Barrick Gold - Taking Steps In The Right Direction

| About: Barrick Gold (ABX)

Barrick Gold (NYSE:ABX) has a strong base of production and reserves and operates in politically safe jurisdictions. The Canadian gold miner has the largest base of resources and reserves in the industry.

The world's largest producer of gold posted better-than-expected quarterly results as it recorded an impairment charge of $8.7 billion and cut its dividend by 75%. The Toronto, Canada-based gold miner also lowered its capital spending forecast for the year and cut its cost estimates for both copper and gold production.

In the current weak gold price environment, Barrick Gold is taking all the steps in the right direction. The company is focused on generating cash-flows, cutting dividend, it sold its energy division and is looking to sell some of its Australian mines. Its copper division is working a little better than plan and its costs are improving substantially. ABX has made headway in cost savings of close to $2.0 billion this year. Keeping in mind the challenges the gold industry is facing in the current price environment, ABX is moving in the right direction and at current valuations present a good investment opportunity.

Industry-Wide Writedowns

As declining gold prices, underperforming assets, and ill-advised deals are making life difficult for the gold companies, a number of them have announced billions in write-downs over the last 2 years. Barrick gold is the latest to join the list.

The company recently announced that it has recorded $8.7 billion in impairment charges largely driven by significant decreases in the metal prices. Barrick Gold joins peers Newmont (NYSE:NEM), Goldcorp (NYSE:GG), and Kinross Gold (KGC), which all posted huge impairment charges linking to the plunging gold prices in 2Q. NEM, GG, and KGC together recorded $6 billion in impairment charges in the second quarter.

ABX's charge is the largest so far. About $5.1 billion stems from the company's delayed Pascua-Lama gold mine in South America, $2.3 billion in goodwill impairments, and $1.3 billion in other asset impairment charges.

2Q Results

After adjusting for several one-timers including impairment charges, loss related to sale of Barrick Energy, and other non-recurring items, ABX reported adjusted 2Q13 EPS of $0.66, beating consensus estimates of $0.56 by 18%. Higher production for both gold and copper and better cost controls than expectations resulted in better-than-expected results.

Gold sales climbed 7% to 1.81 million ounces in the second quarter, while copper sales rose 16% to 135 million pounds. Performance at the company's Lumwana copper project in Zambia had improved and it now expects copper costs to average $1.95 to $2.15 a pound in 2013, down from a previous estimate of $2.10 to $2.30.

Barrick reported total gold production of 1.81 million ounces at cash costs of $552 per ounce, compared to 1.80 million ounces at cash costs of $561 per ounce in 1Q13. The company reported higher production than most analysts were expecting, largely driven by the North America and Australia Pacific regions, while South America was in-line. All regions also reported lower-than-expected costs, except for African Barrick, which had previously reported results.

Copper segment operating profit rose 152% from the previous quarter as C1 cash costs fell by 29% to $1.75 per pound. The company noted that utilizing option collar hedging strategies the company has protected the downside on approximately half of its remaining 2013 copper production at an average floor price of $3.50 per pound.

Dividend Slashed by 75%

To improve liquidity in the current weak gold price environment, the company has decreased its quarterly dividend to $0.05 per share from $0.20 per share. The Canadian gold miner's move to cut its dividend is expected to result in $300 million in savings in 2H13 and $600 million next year. The dividend is payable on September 16, 2013, to shareholders of record at the close of business on August 30, 2013

Pascua-Lama Delay To Reduce Capital Spending By $1.5-$1.8 billion

Located on the border between Chile and Argentina, Pascua-Lama is one of the world's largest gold and silver resources with nearly 18 million ounces of proven and probable gold reserves, 676 million ounces of silver contained within the gold reserves, and an anticipated mine life of 25 years. It is expected to produce an average of 800,000-850,000 ounces of gold and 35 million ounces of silver in its first full five years of operation at very low costs.

The company said in June that it received a resolution from Chile's Superintendence of the Environment ("SMA") that required completion of the project's water management system in accordance with previously granted environmental permits before other construction activities in Chile could resume.

With a proposed 18-month timeline to construct the required water infrastructure and development construction to re-commence thereafter, first production has been pushed to mid-2016 from previous estimates of 2H14.

The Pascua-Lama delay has helped Barrick reduce capital spending for the year by about 20%, to $4.5-$5.0 billion (from $5.7-$6.3 billion). For the current year, capital expenditures are expected to be reduced by approximately $0.7-$0.8 billion to $1.8-$2.0 billion and for 2014 capex is expected to be reduced further by $0.8 - $1.0 billion. However, the final cost of building Pascua-Lama is expected to exceed current budget of $8.5 billion.

ABX is expected to update the final capex numbers for the project in 3Q13, with previous published estimates of $8.0 - $8.5 billion, while analysts are expecting revised capex at ~$9.5 billion. As of June 30, 2013, approximately $5.4 billion was spent on the project.

Sale Of Barrick Energy Further Improved Liquidity

The company also announced late last month that it has divested Barrick Energy for a total consideration of $442 million, including cash of $394 million plus a royalty on certain assets valued at $48 million. The proceeds will be recorded in the third quarter of 2013. ABX recognized a loss of $0.5 billion related to the deal in 2Q13.

In addition, a process to divest certain Australian assets is well advanced, and the company continues to actively pursue other portfolio optimization opportunities, including the divestiture of other non-core assets.

Commenting on the deal the company said in a statement, "As part of its disciplined capital allocation framework, Barrick is actively pursuing opportunities to optimize its portfolio, including through opportunities to divest certain non-core assets. The sale of Barrick Energy represents such a divestiture in this ongoing process."

The sale of Barrick Energy is positive for ABX, as it should improve the company's liquidity position and provides further indication of ABX's conviction of sticking to its strategy of selling non-core assets. More importantly, this is the first divestiture of one of Barrick's non-core assets and the market has been waiting for execution on asset rationalization. ABX's high quality asset base will provide a low cost and highly renewable base, with rationalization.

Valuation & Financials

ABX is trading at very attractive valuations. It has a forward P/E of 6.7, compared to 14.4 of S&P 500. ABX has a PEG ratio of 0.7.

The company has a price-to-book ratio of 0.7 compared to the industry average of 1.0 and ABX's own 5-year average of 2.2. It has price-to-sales ratio of 1.2 compared to the historical average of 3.8 and industry average of 2.5. Finally ABX has a price-to-cash flow ratio of 3.2 compared to the industry average of 8.1 and the company's 3-year average of 9.2. The company has a new dividend yield of 1.2%.

Barrick Gold has $2.4 billion in cash and $15.8 billion in total debt, in addition to $4.0 billion available under its five-year credit facility. ABX's current consolidated tangible net worth is $6.3 billion, well above the $3.0 billion covenant threshold related to its undrawn credit facility.

Investment Thesis

We have a buy rating on ABX. At current valuations the company provides a good investment opportunity. ABX is moving in the right direction in a challenging gold price environment. Although the company reported an impairment charge of $8.7 billion, the Toronto-based gold miner has made good headway in cost savings of close to $2.0 billion this year. The reduced dividend is also expected to result in annual savings of $600 million.

Compared to peers, the company is doing a better job in cutting costs, pushing its all-in sustaining costs down by over $100 per ounce to $900-$975 per ounce. While keeping the production unchanged, the company has been able to lower cash costs to $575-$610 per ounce compared to guidance of $610-$660 per ounce.

In addition to its capital cost reductions of $500 million in the first quarter, the company has further identified approximately $1.5 billion in cost reductions. As part of its cost-cutting initiatives it has already reduced corporate staff by 30%, and is evaluating further changes and cost reductions. These cost cuts combined with capital expenditure deferrals and the dividend cut will result in enough cash for the company to fund Pascua into production without additional borrowings.

In addition to the recently announced sale of Barrick Energy, Plutonic and Yilgarn South are possible divestiture candidates. Moreover, Porgera could also be sold if all-in cash costs do not fall below $1,000 per ounce. These divestitures should improve the company's liquidity position further and provides indication of ABX's conviction of sticking to its strategy of selling non-core assets.

ABX's decision to target each of its mines with all-in costs above $1,000 per ounce for mine revisions, shutdowns or dispositions is one of the clearest strategies any gold company has adopted on how to start addressing challenges the industry is facing in the current gold price environment. This gold miner is clearly headed in a positive direction.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.