Q2/2013 reporting time will soon be upon us and our best guess has a good number of gold miners wondering how they can best break the bleak news of their quarterly results to their investors. One of the worst in class, Barrick Gold (ABX), came out front-running with a news release that wasn't pretty, but expected by many in its ugliness. Timing was well-chosen with a July 4 long weekend coming up for many market participants and the week being very thinly traded in general.
The news release mainly concerned the ill-fated Pascua-Lama project which sits atop the Andes Mountains in South-America straddling the border between Chile and Argentina. It is touted to potentially become one of the largest and lowest cost gold mines; if Barrick Gold manages to get it into production, that is. Currently all development works on the Chilean side are suspended due to a court order achieved by the resilient Chilean Diaguita Huascoaltino community populating the area underneath the mine in Chile.
Barrick has recently been fined $11.6M for environmental violations at the mine. According to this report further explanations with regards to this fine have been demanded by Chile's supreme court. In the tradition of this project, we would not rule out further unpleasant news to surface when these explanations are published.
The Pascua-Lama development was originally budgeted at $3.3B - $3.6B. After a review in 2011, capex estimates were revised to $4.7B - $5.0B. Last we heard the number was $8.5B and counting. Even the possibility of shelving the project was mentioned in the first 2013 earnings call.
Barrick Gold also has obligations to pay Royal Gold (RGLD) a royalty on some of the precious metal output from the mine once operational; and more importantly, the company has given a completion guarantee to Silver Wheaton (SLW) as part of a deal that saw Silver Wheaton contribute $625M towards capex in 2009 in exchange to buy 25% of the produced silver for a discounted price of $3.90. If the mine is not completed by December 31, 2015, then Silver Wheaton has the right to ask for its money back. Silver Wheaton will be thinking of ways to manage its share of the disaster as confirmation has now been given that Pascua-Lama will not be completed by that dead line. For the moment, Silver Wheaton has extended the deadline by one year to December 31, 2016, and has reduced the guidance for 2017.
The news release described a new timeline to first production in mid-2016. Whether or not this timeline will hold will depend on the response of Chilean authorities to a plan submitted by Barrick concerning water management at Pascua-Lama. This is how the company puts it:
"The company has submitted a plan, subject to review by Chilean regulatory authorities, to construct the project's water management system in compliance with permit conditions for completion by the end of 2014, after which Barrick expects to complete remaining construction works in Chile, including pre-stripping."
We find this formulation puzzling. How come the implementation of water management measures according to rules known for years suddenly take such an extraordinary amount of time? To us this sounds like an implicit confession, that Barrick had originally not intended to implement these measures in compliance with stipulated rules. This sounds conspicuously like a confirmation of concerns voiced by the local opposition to the mine. Any more skeletons in this closet, we wonder?
Investors will not be amused by the other piece of information found in the news release. Barrick is preparing the ground for an impairment charge to be announced with the Q2/2013 report. The company estimates this charge to come in between $4.5B and $5.5B for Pascua-Lama alone. Additional writedowns for other assets are also a stated possibility. In any case, the company's retained earnings of $3.9B will soon be history.
Last time we wrote about Barrick Gold, we were told with some doubtful authority that all problems have been baked into the share price and that Barrick was a buy "at these levels." Since then the share price has dropped further, and we are looking forward to the same people telling us yet again that everything was baked in and Barrick is a "buy".
We beg to differ. If anything, we suggest to trade Barrick on the short side, even if gold stops dropping. All in our humble opinion.