Wall Street is now well into the quarterly orgy of earnings reports from Corporate America. The results thus far have largely been less than inspiring, which isn't surprising considering the lackluster economic environments in the United States, Europe, and Japan, plus the deceleration evident in China. Viewed broadly, revenue is barely growing and earnings per share, which are being enhanced by stock repurchases and cheap credit, are rising at anemic single-digit rates. The stock market, as measured by the Dow Jones Industrial Average (DIA) and Standard & Poor's 500 Index (SPY), continues to advance, however, regularly setting new all-time highs. Indeed, new records were set Friday (May 3, 2013), as investors responded enthusiastically to government data that showed better-than-anticipated job growth in April and upwardly revised figures for the previous months. As with many of the individual stocks that have performed well of late in response to earnings reports, though, the trigger for the ascent was more excitement over the actual numbers beating depressed expectations rather than their being good on an absolute basis.
Beyond the expectations game that has become such an important feature of Wall Street, the prevailing driving force for investors around the globe seems to be the search for safety and yield in a nearly zero-interest rate world. This reality is clearly manifested in the massive flow of money into the stocks of utility, healthcare, large-capitalization industrials, and slow-growing consumer product companies. As such, valuations of most of the stocks that possess many of the characteristics that we consider important - long track records of prosperity, strong balance sheets, geographic diversification, good growth prospects, and dividends - have become rich, not necessarily in the context of historically low interest rates, but when viewed in the prism of both growth prospects and the inevitable rise in rates. Indeed, the valuations of many of the stocks we've recommended - Honeywell (HON), 3M (MMM), United Parcel Service (UPS), Illinois Tool Works (ITW), and United Technologies (UTX), to name a few - have expanded considerably even though the macro operating environment hasn't improved meaningfully and most of the structural problems that have unnerved investors for years have barely been addressed. Considering our assessment of the stock market's valuation, global financial conditions, and attraction to value and yield, we recommend Barrick Gold Corporation (NYSE: ABX), even though not huge fans of gold itself.
Thirty-year-old Barrick Gold Corporation is the leading gold mining company in the world in terms of production, reserves, and market capitalization. The Canadian concern has operating mines or projects in Canada, the United States, the Dominican Republic, Peru, Chile, Argentina, Tanzania, Zambia, Australia, Papua New Guinea, Saudi Arabia and Pakistan. Barrick's long-standing strategy of growing its reserve base through a combination of acquisitions and exploration has proved extraordinarily successful, reflected, in part, by an impressive portfolio of operating mines, development projects with substantial potential, and extensive geographically diverse land positions on many of the world's most prospective trends that could be exploited under the right circumstances. The large miner's success is also manifested in a stock price that has appreciated manifold, as well as by top- and bottom-lines that have risen strongly over the decades.
Barrick's lengthy track record of success and prosperity notwithstanding, the company's common stock has been under considerable pressure since peaking, 180% above today's closing price, in the late summer of 2011. Macro and industry-wide issues such as sluggish economies, nonexistent inflationary pressures, and falling commodity prices have certainly been negative for the stock. So, too, have problems that are more specific to Barrick, including rising production costs and falling earnings. Regulatory, political, and legal setbacks in some foreign countries, which are part of the cost of doing business in far-flung regions of the world, have also weighed on the shares of late, as they magnify anxieties over the combination of a relatively large debt load and prospects for a bottom-line rebound.
At the prevailing stock price, however, all of the company's problems appear to be amply discounted. Indeed, the shares are now trading at levels last seen almost a decade ago (other than briefly in 2008's market crash), when earnings, cash flow, book value, and dividends were mere fractions of current figures. Per-share earnings, for example, were $3.82 last year and will probably be north of $3.00 both this year and next, compared with less than $0.50 in the first four years of the last decade. The price/earnings multiple, on Wall Street's consensus earnings estimate ($3.33) for this year, is a mere six, which is considerably below the long-term historical norm of greater than 15; ABX shares have typically traded at a premium valuation to the market, which is certainly not the case now. The dividend yield, meantime, the Holy Grail for investors these days, is a healthy 4%, which is about four times the issue's norm and is a benefit afforded by the sharp stock-price drop. Significantly, too, the dividend seems safe, as it's comfortably covered by earnings, the company has no history of cutting the payout, and the balance sheet remains decent; Barrick borrowed $3 billion earlier this week at reasonably attractive rates. Moreover, asset sales are a possibility if additional cash is needed. Last, the shares are trading at a discount (roughly 20%) to book value, a situation that has almost never existed in its history; the one exception in the past 15 years was in late 2008 when the market price was a few dimes below book value. All things considered, these shares have the potential to return handsome rewards over the next three years, as valuations normalize, while paying investors a good dividend yield for their patience. Our three-to five-year price target is $45-$65, with the mid-point representing a modest 12.5 multiple of our $4.35 earnings projection.
Barrick Gold Corporation is the largest producer of gold in the world, with more than two dozen operating mines and development projects spread out over five continents. The Toronto, Canada-headquartered concern, founded in 1983, also produces significant amounts of copper and has interests in properties that yield silver, nickel, and oil and gas; the hydrocarbon subsidiary serves mainly as an economic hedge to its exposure to fuel prices. As of December 31, 2012, the company had proven and probable mineral reserves of 140.2 million ounces of gold (compared with 139.9 million ounces at the end of 2011), 1.05 billion ounces of silver contained within the gold reserves, and 13.9 billion pounds of copper (up from 12.7 billion). It also had approximately 26,140 employees. Barrick's gold mines are concentrated in North America, South America, and Australia Pacific, regions that constitute three of the miner's seven business units, along with its 73.9% interest in the Africa-focused ABG entity, a global copper business unit, the oil and gas unit, and a capital projects business unit. Some 80% of the gold reserves are in the Americas. In 2012, gold production totaled 7.4 million ounces (versus 7.7 million in 2011), with North America accounting for 47% of production; Australia Pacific, 25%; South America, 22%; and Africa and elsewhere, 6%. Copper production was 468 million pounds last year, compared with 451 million pounds in 2011.
Barrick's growth strategy consists primarily of building its reserve base through the purchase of low-cost, long-life mines and developing existing properties. The company has completed a large number of acquisitions in its history, the most recent of any significance being the July 2011, $7.5 billion addition of Equinox Minerals Limited, whose primary assets were Lumwana copper mine in Zambia and the Jabal Sayid copper project in Saudi Arabia. Through development of its existing asset base, the company's plan is to achieve annual gold production of 8 million ounces by 2016. The new Pueblo Viejo mine in the Dominican Republic, for example, began producing gold last August, and output for 2013 is anticipated to approximate 500,000 to 650,000 ounces. The hugely expensive Pascua-Lama mine that straddles the Chile and Argentina border is also expected to be a significant contributor by mid-decade (discussed below). Important, too, as part of a new strategy, announced last year, designed to optimize returns, the miner is putting added emphasis on aggressively managing costs, postponing the building of new mines for now, and exercising maximum discipline in the allocation of capital. And with regard to the latter, Barrick had (ultimately unsuccessful) discussions with China National Gold Group Corporation in the second half of 2012 concerning a possible sale of its 73.9% stake in African Barrick Gold.
In 2012, 47.1% of companywide gold production was from North America, which held 42.4% (59.5 million ounces) of Barrick's gold reserves at the end of the year. The company has 10 mines (six 100% owned) in the region, including two of its largest and most productive, the wholly-owned Goldstrike and Cortez properties, both located in Nevada, which yielded a combined output of 2.544 million ounces of gold in 2012 and closed out the year with reserves totaling 27.4 million ounces. Another important mine in the region is the 60%-owned Pueblo Viejo property, which holds 15.0 million ounces of gold and only achieved commercial production earlier this year. The North American Regional Business Unit (RBU) produced approximately 3.5 million ounces of gold in 2012, at a total cash cost of $500 per ounce and cost of sales of $2.3 billion, compared with approximately 3.4 million ounces of gold in 2011, at total cash costs of $426 per ounce and cost of sales of approximately $1.9 billion.
In 2013, management expects gold production in the region to range from 3.55 to 3.70 million ounces, with Pueblo Viejo slated to ramp up to full production by the second half of the year and increased production at Ruby Hill, offset by reduced output at some of the other mines. All-in sustaining cash costs are anticipated to be $820 to $870 per ounce and total cash costs are expected to be $495 to $545 per ounce. Cash costs are expected to be helped by lower costs at Pueblo Viejo, offset by the impact of higher labor, energy and consumable costs due to an expected increase in mining activity. First-quarter results were largely in line with expectations, and the company's guidance hasn't changed since the beginning of the year - 0.87 million ounces of gold were produced at all-in sustaining and total cash costs of $770 and $487 per ounce, respectively.
In 2012, the South American RBU accounted for 22.0% of aggregate gold output, and it ended the year with 36.9% of the company's gold reserves. Barrick has three gold mines in the region, two in Peru - Lagunas Norte and Pierina - and Veladero in Argentina. It also has two development projects in the region that are now part of the company's Capital Projects business unit but will eventually become part of the South American RBU. Significantly, the Pascua-Lama mine in Chile and Argentina and the 75%-owned Cerro Casale project in Chile have reserves of 17.9 million and 17.4 million ounces, respectively, the two largest totals in Barrick's large portfolio of mines. This RBU produced 1.6 million ounces in 2012, at total cash costs of $467 per ounce and cost of sales of $1.1 billion, compared with 1.9 million ounces in 2011, at total cash costs of $358 per ounce and cost of sales of $905 million.
Gold output is expected to approximate only 1.25 to 1.35 million ounces this year, however, as an increase in tons placed on the leach pads at all mines is anticipated to be offset by the impact of lower average head grades. All-in sustaining cash costs are expected to be $875 to $925 per ounce and total cash costs are expected to be in the range of $550 to $600 per ounce. Total cash costs per ounce are expected to be higher this year due to the impact of lower grades and consequent higher tonnage production, which requires increased usage of equipment and consumables. In the March quarter, the RBU produced 0.37 million ounces of gold, at all-in sustaining and total cash costs of $638 and $405 per ounce, respectively. Higher silver by-products credits at the Veladero mine and delays in sustaining capital spend at Pierina and Veladero helped depress all-in sustaining costs. Costs will likely rise later in the year, however, and as with the North American region, management's guidance remained unchanged.
The Australia Pacific RBU accounted for 24.6% of Barrick's gold production in 2012 and it held 11.8% (or 16.6 million ounces) of its reserves at yearend. The company has six mines in the region, four that are wholly-owned and a fifth in which it owns 95% (Porgera in Papua New Guinea); the other mines are in Australia. The region produced 1.8 million ounces of gold last year, at total cash costs of $803 per ounce and cost of sales of $2.0 billion, compared with 1.9 million ounces at total cash costs of $621 per ounce and cost of sales of $1.6 billion in 2011.
Gold output is anticipated to be flattish in 2013, at 1.70 million to 1.85 million ounces. Expenses are expected to continue rising, however, due to lower production at Kanowna, higher costs at Porgera, and generally higher labor costs. All told, all-in sustaining cash costs are expected to be $1,200 to $1,300 per ounce, while total cash costs are expected to be between $880 and $950 per ounce. In the first quarter, Australia Pacific produced 0.45 million ounces, at all-in sustaining and total cash costs of $1,096 and $785 per ounce, respectively. Here, too, the guidance for the full year remains unchanged from early in the year.
In early 2010, Barrick's board of directors approved a plan to create African Barrick Gold plc (ABG), to hold the company's African gold mines, gold projects, and gold exploration properties. On March 24, 2010, ABG issued approximately 25% of its equity to investors on the London Stock Exchange (LSE) through an initial public offering. Due to the exercise of an over-allotment option, though, the Canadian miner's interest in ABG slipped to 73.9%. As such, Barrick no longer has an African RBU but for all intents and purposes, ABG is treated as an operating segment, with its assets, liabilities, and operating results consolidated with those of its parent company. ABG's operations consist of the Bulyanhulu mine, its 70% interest in the Tulawaka mine, the North Mara mine and the Buzwagi mine, all located in Tanzania. As noted above, ABG was the subject of since-terminated divestiture discussions last year. In 2012, about 6% (or 463,000 thousand ounces) of the company's gold production stemmed from Africa, at total cash costs of $949 per ounce and cost of sales of $590 million, compared with 509,000 ounces at total cash costs of $692 per ounce and cost of sales of $517 million.
In 2013, Barrick expects equity gold production from ABG, reflecting Barrick's 73.9% equity interest, in the range of 400,000 to 450,000 ounces, with the anticipated decline due to labor issues at Bulyanhulu and closure of the Tulawaka mine in the first half of the year. All-in sustaining cash costs are expected to rise sharply, to $1,550 to $1,600 per ounce, and total gold cash costs are expected to be $925 to $975 per ounce. Ongoing activities to boost production could lift output beyond this year, though.
Global Copper Business Unit
Barrick's global copper business unit consists of the Zaldivar mine in Chile and the Lumwana mine in Zambia, which was part of the Equinox transaction in mid-2011. The unit also holds two projects that are still in various stages of development, the Jabal Sayid copper project in Saudi Arabia and the Kabanga nickel project in Tanzania. In 2012, the copper business produced 468 million pounds of copper, at cash costs of $2.17 per pound, fully allocated costs of $2.97 per pound, and cost of sales of $1.28 billion. By comparison, the unit produced 451 million pounds of copper in 2011, at cash costs of $1.71 per pound, fully allocated costs of $2.30 per pound, and cost of sales of $915 million. The 4% year-over-year increase in output is due primarily to the timing of the Lumwana acquisition. The sharp increase in costs is also due mainly to the inclusion of Lumwana's cost of sales for the full year in 2012. Cash costs per pound, meanwhile, increased by 27% due to the impact of higher unit production costs at Lumwana.
The company expects 2013 copper production to be in the range of 480 to 540 million pounds, at cash costs of $2.10 to $2.30 per pound and fully allocated costs of $2.60 to $2.85 per pound. Production at Zaldívar is expected to be approximately the same as in 2012, at slightly lower cash costs primarily due to a decline in the price of sulfuric acid. Lumwana copper production is expected to increase due to the impact of higher ore grades and higher mill throughput, while cash costs are expected to decrease slightly compared to 2012. Copper production in the first quarter of 2013 was 127 million pounds, at cash costs of $2.26 per pound and fully allocated costs of $3.00 per pound.
Looking beyond this year, copper output should get a boost from the Jabal Sayid mine, which was also part of the Equinox deal. Construction of the processing infrastructure was completed in the third quarter of 2012, but its commissioning has been delayed by regulatory issues related to safety and security. Production is now expected to commence in 2013, with annual output likely to approximate 100 to 130 million pounds in the first five years of operations.
Capital Projects Business Unit
The gold and copper mining company's Capital Projects Business Unit (CPBU) focuses on managing large projects and overseeing new mines. It essentially specializes in taking a new project from the beginning stages and implementing all the steps necessary to achieve commercial production, at which point the nascent operational mine is transferred to a RBU. The Pueble Viejo mine, for example, was part of the CPBU until it achieved commercial production earlier this year (January) and is now managed by the North American RBU.
The CPBU now consists of the potentially prolific aforementioned Pascua-Lama and Cerro Casale projects in Chile/Argentina and Chile, respectively. It also includes the company's 50% interest in the Donlin Gold project in Alaska. Pascua-Lama is one of the largest gold and silver resources in the world, with almost 18 million ounces of proven and probable gold reserves, 4,675 million ounces of silver, and an expected mine life of 25 years. It's expected to produce an average of 800,000 to 850,000 ounces of gold and 35 million ounces of silver in its first five full years of operations, at all-in sustaining and total cash costs of $50 to $200 per ounce, which are well below the company's current levels.
Significantly, though, even though work on the Argentine side of the Pascua-Lama mine is continuing, construction on the Chilean side was halted in mid-April by a Chilean court that said it threatens the water supply of an indigenous community and pollutes glaciers. The commercialization start date has been delayed by at least six months, to the second half of 2014, and the project's cost has surged from an original $3 billion to roughly $8.5 billion. As of December 31, 2012, approximately $4.2 billion had been spent ($4.8 billion as of March 21, 2013) and construction was approximately 40 percent complete. In 2012, Barrick revised its execution strategy for developing Pascua-Lama by transferring overall project management to Fluor, a leading global engineering and construction management contractor that successfully managed the company's recently completed Pueblo Viejo mine. All that said, management indicated several days ago that it is evaluating all alternatives, including the possibility of suspending the project, in view of the legal and regulatory uncertainties, as well as the current commodity price environment.
Mining is a capital-intensive business, requiring substantial amounts of capital to explore for deposits and develop mines. Moreover, mining costs have risen massively over the past few decades, fueled by surging inflation in the prices for energy and building materials. As such, the global gold production industry is dominated by a small number of large producers, namely AngloGold Ashanti (AU), Rio Tinto (RIO), Freeport McMoRan Copper & Gold (FCX), and Newmont Mining (NEM), along with Barrick Gold. There are a few smaller players like Gold Fields (GFI) and Harmony Gold (HMY), too, but it's unlikely they'll ever achieve the scale and scope of the major players. Significantly, too, gold output has risen at a sub-1% annual rate since the turn of the century despite the surge in prices, most likely reflecting both the challenging economics of production and a dearth in new large mines.
Gold, which is easily bought and sold, is held as an asset class for a variety of reasons, including as a store of value and a safeguard against the collapse of paper assets such as stocks, bonds and other financial instruments, as a hedge against future inflation, and for portfolio diversification. Governments, central banks and other official institutions hold significant quantities of gold as a component of exchange reserves. There's also substantial and long-standing physical demand for the pretty metal for jewelry, particularly in India and China. Moreover, in recent years, concerns over global economic growth, geopolitical issues, sovereign debt and deficit levels, bank stability, inflation prospects, and continuing accommodative monetary policies put in place by many of the world's central banks, including by the U.S. Federal Reserve, has fueled strong investment demand, facilitated by the creation and growth of products such as Exchange Traded Funds (ETFs), which hold gold bullion. Gold price is inherently volatile, flagellated not only by supply-demand dynamics but also by geopolitical and socioeconomic developments. In 2012, the price ranged from $1,527 per ounce to $1,796 per ounce. The average market price for the year was an all-time record high of $1,669, which is 6% higher than the average for 2011. It has fallen appreciably in recent weeks, though, closing today at $1,466.
Copper is a corrosion-resistant metal that allows excellent electrical conductivity and heat transfer. It is used principally in telecommunications, power infrastructure, automobiles, construction, and consumer durables. Copper is traded on several commodity and futures exchanges. The market is volatile and cyclical, influenced by numerous factors, including: the worldwide balance of copper demand and supply; rates of global economic growth, particularly in China, which has become the largest consumer of refined copper in the world; speculative investment demand; the availability and cost of substitute materials; and foreign currency exchange rates. Over the last 15 years, prices on the London Metals Exchange ranged from a low of 61 cents a pound to a high, reached in February 2011, of $4.62. In 2012, the LME copper price traded in a range of $3.27 to $3.98 per pound. Prices will undoubtedly continue to be influenced by demand from Asia for the foreseeable future.
Barrick has historically used forward contracts to sell its gold, enjoying relatively predictable prices and stable revenue. The miner began to simplify its hedging strategy in 2002, however, and its entire gold production in 2012 was delivered into the spot market, realizing the market average price of $1,669, up from the $1,578 average realized in the previous year. Barrick is more active in managing the prices received for its copper output. Indeed, it's bought put options on about half its expected production for 2013 to lock in an average of at least $3.50 per pound, while also selling call options, at a strike price of $4.25 to defray the cost of its hedging activities. In 2012, the company realized an average sale price of $3.57 per pound, four cents less than the LME average. The average price realized in 2011 was $3.82 per pound.
Why is the Stock so Depressed?
Gold prices have fallen of late, even though they are still well above levels that prevailed for most of the past several decades. The price of ABX stock, on the other hand, has been in a virtual free fall since peaking at $55.95 on September 8, 2011, plunging 64% in less than two years, a period during which most equities performed very strongly. It's off 42% year to date and 32% just since the beginning of the second quarter. Falling commodity prices, particularly of gold, are undoubtedly a depressant for the entire mining sector, as is the persistent rise in production costs. More specific to Barrick, investors are clearly anxious about the delays, rising costs, and uncertainties at the Pascua-Lama project, which is draining substantial resources and is critical to management's plans to boosting long-term gold output (and reducing overall production costs). The miner's relatively large debt load may also seem heavier to investors in the light of falling commodity prices, rising production costs, slipping output volume, and troubles at a critical project.
Results: Past, Present, and Future
Barrick's per-share revenue compounded at a mid-teens annual rate over the past 10 years, fueled by a combination of acquisitions, internally generated production growth, and substantial improvements in the price realized for its output, rising from $3.63 in 2002 to $14.53 in 2012. The miner's bottom line advanced at an even faster pace, reflecting the margin benefits of both outsized price inflation and economies of scale. Share net averaged just $0.55 in the first three years of the last decade but a whopping $3.82 in the current decade's initial three years.
Total revenue in 2012 was $14.5 billion, 1.6% higher than the 2011 tally. The $311 million improvement is due primarily to higher realized gold prices and higher copper sales volume. Gold and copper revenue totaled $12.6 billion and $1.7 billion, respectively, both up 3% compared to the prior year, due mainly to higher realized gold prices and higher copper sales volumes, partially offset by lower gold volume (7.42 million ounces versus 7.68 million ounces) and lower realized copper prices. Realized gold prices of $1,669 per ounce in 2012 were 6% higher than in 2011, principally due to higher market gold prices. Excluding a slew of nonrecurring charges, including a $4.4 billion after-tax impairment charge related to the company's global copper business, Barrick earned $3.8 billion last year, down almost 16% from the $4.5 billion earned in 2011. Earnings and profit margins were hurt by both the slight deterioration in the sales mix and sharply higher production costs. All-in sustaining cash costs for gold, for instance, were $945 per ounce in 2012, compared with $752 in 2011. Total cash costs, meantime, rose from $460 per ounce to $584.
Revenue is likely to slip to around $14.2 billion in 2013, hurt by the anticipated drop in gold output (7.0 to 7.4 million ounces) as well as falling commodity prices; production is rising in North America, with the ramp-up at Pueble Viejo, but this is likely to be more than offset by declines at Veladero and Lagunas Norte. Copper volume could rise by as much as 70 million pounds, though, lifted by gains at the Lumwana mine. Still, with production costs anticipated to increase further, per-share earnings will probably fall further, from $3.82 in 2012 to $3.35 this year. In view of the development activities discussed above, though, the top line should rebound and approximate $14.6 billion in 2014, which may well support profits of around $3.55 a share. Looking further out, our projections have revenue reaching $16.0 billion by 2017 and share net approximating $4.35, but this assumes, among many other things, progress at Pascua-Lama and gold prices holding close to current levels.
Barrick's presence in many different countries, including several in which markets don't operate nearly as freely as ours, obviously inject a large measure of risk. A fragile world economy adds further uncertainly, with significant implications for commodity demand, as well as for their prices. The miner's broad geographic diversification, considerable resources, and proven track record suggest, however, that the challenges that have derailed its bottom line and stock price will prove temporary. Rock bottom valuations, a discount to book value, and a good dividend yield provide solid downside support near the current stock price. And any positive developments concerning Pascua-Lama and/or an earnings recovery will most likely fuel a strong rebound in the price, driven mostly by an expansion in the P/E multiple. All in all, we think the stock will generate healthy double-digit annual total returns over the next three to five years, even without outsized profit gains.