Barrick's Earnings Call Seen As Pulse Of Large-Cap Gold Market
Barrick (NYSE:ABX), one of the world's leading pure gold plays will be giving its earnings call in the middle of this week. It will no doubt be closely followed and taken as a pulse of the natural resources sector at large. BCA Research has already set a positive tone ahead of the call by announcing that 2013 could be a "breakout year for top gold companies." In particular, BCA argues that
"Investor disappointment over the past three years has left gold equities cheap, unloved and under owned. The final catalyst for gold shares may well be intense investor pressure to contain cost overruns and focus on efficiency. Six gold mining CEOs lost their jobs in 2012.
Such shakeups usually herald a major shift in corporate strategy, and gold equities could do well, even if gold prices go nowhere".
Count former Barrick CEO Aaron Regent as one of the executives that was shown the door. The company cited poor stock performance as the reason for his departure. It was, if anything, symptomatic of the industry climate: high costs and political instability in sites of operations. Barrick's founder and Chairman of the company has been candid about the matter--explaining that Barrick is "fully committed to maximizing shareholder value, but [has] been disappointed with… share performance." This decision caught many analysts off guard, since Barrick's stock performance was not meaningfully underperforming competitors.
However, what has been relatively interesting to observe is how companies, like Barrick, have underperformed the bullion and gold ETFs. The reason? These companies face special risks from rising costs, resource scarcity, and worsening political tension--the threat of nationalization, higher taxes and more. For Barrick, in particular, the concern has been accelerating costs at the Pascua-Lama gold mine near Chile and Argentina.
Are Junior Miners, Like Southern USA Resources (GM:SUSA), A Good Alternative?
In financial theory, the riskiest assets tend to outperform--a long-held sentiment supported by index records both between small-cap and large-cap stock and between value and growth stock. As a junior miner venturing into a relatively untapped region, Southern USA Resources carries significant potential. In my view, the market has largely discounted the upside of this stock by focusing more on the downside. As I explain below, it actually lacks many of the risks that Barrick and other large miners face due to its vertical integration and U.S. focus.
In a previous article, I calculated the theoretical extraction value of SUSAR No. 1 at $4 per share assuming a 20-year project life and peak extraction around the 7th year. This calculation was based on a press release issued by the firm reporting that "the belt of gold bearing ore" within SUSAR No. 1 contains "several hundred thousand ounces of gold". No matter how you slice it, with gold at $1,700 per ounce, it's hard to not find SUSA undervalued by a good margin based on that corporate announcement--the stock is only valued at around $40M, or $1.32 per share.
But you can have a project that overlies El Dorado and is still uneconomical if it's impossible to actually get to the gold. This is why it is important to look at the efficiency of gold mining. Fortunately, the company has mined 20,000 tons of raw material and produced 7,500 tons of gold bearing material to date: a strong ratio of 1 : 2.7. The acquisition of equipment that can process 75 tons of material per hour for 50 hours a week improves productivity even more. Accordingly, in its "strong buy" research report on SUSA, Caprock Risk Management highlighted how the company is a low cost producer because it "owns all of the equipment on site in addition to owning both the land and mineral rights for the flagship mining operation". The analyst at the research firm believes that this degree of vertical integration will enable the company to produce gold at about $375 per ounce.
By contrast, average cash costs for miners have risen to $730 per ounce according to a report by Thomson Reuters GFMS's Gold Survey 2012. If Caprock's figures are accurate, that implies that SUSA has double the mining efficiency of peers. It is therefore surprising that the company would trade at 7.8x projected 2013 earnings while the sector average for mature miners is 20.4x. This represents more than a 60% discount.
Important Risk Factors
Despite the indication of large amounts of gold reserves, there are several reasons why investors are on the fence. First, the balance sheet is relatively thin. The amount of cash on hand is a fraction of the firm's market cap. If the company is not able to get access to a reasonable credit line, it won't be able to get to any of the gold it is reporting barring an outright buyout. Second, the company's operations are in Alabama--a state that hasn't seen any meaningful gold production in decades after it was abandoned in the 19th century. SUSA's plan is to take advantage of the existing old mine shafts to bring down costs. Third, investors are becoming more optimistic about the economy. Gold has been traditionally seen as a hedge against inflation, and if the economy is proceeding smoothly, governments would be hard pressed to justify monetary and fiscal stimulus packages that end up depreciating the dollar. Smaller-cap stocks are particularly vulnerable to the transition away from gold equities, since they tend to carry higher betas.
Reward Outweighs Risk
SUSA is a speculative stock that will see a larger degree of volatility. However, essay results indicate that the flagship project holds several hundred thousand ounces of gold, and the company can reportedly get to that gold at half the traditional cash cost. And while the balance sheet is thin, it is important to keep matters in perspective.
Take a look at Goldcorp's (GG) finances when it was relatively small: In one of the producer's first public filings with the SEC in March 1997, it reported $76.4M in current assets and $32.7M in current liabilities for the year ending December 31, 1996. At the time, it was operating at 41,513 ounces of gold sales per quarter (1Q96) back when gold was selling for around $340 per ounce. 1.4 million tons were mined in the quarter ending 1Q96. Around the time of the filing, Goldcorp was a multi-billion dollar company.
SUSA, however, is just getting started with its mining, and it has produced 7,500 tons of gold as a start. Therefore, it's not all that illuminating looking at the balance sheet this early in the game. With indications for several hundred thousand ounces of gold, financiers will be readily available--I encourage buying at this startup phase and ahead of Barrick's earnings call to get the most of the upside. At a valuation of just $40 million, SUSA looks undervalued on a forward P/E basis, a present value basis, and a historical comparison basis.
Additional disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. We seek business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients, repeat or new, who may now or in the future have a position in any company mentioned herein. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.