For several months I have been suggesting that Barrick Gold (ABX), owner of the world's largest gold reserves and lowest cost mines is a value buy suffering from suppressed PM (precious metal) prices, hostile sentiment and over-zealous scrutiny. For a month I've been preparing to write a follow-up to my previous focus piece on ABX, written when it was putting in a secular bottom. Then, a couple of days after Barrick's $3 billion tender of notes (secured by 163.5 million common shares), SA Editor-in-Chief Hoffman invited writers to make a bullish case for the company. For those who can wait a year for significant gains and 2-3 years for major gains, such a case certainly has merits. First I will review the background.
The problems ABX has suffered in the past 18 months have their inception in a grand strategy whose various pieces never quite came together and whose failure to coalesce was rammed by falling bullion prices. Founder, Director (since 1984) and Chair Peter Munk's vision to make ABX a major mixed commodity miner like Rio Tinto (RIO) or BHP Billiton (BHP). In that quest he bid for copper giant Freeport-McMoRan (FCX) but was outdone when FCX itself became a behemoth by acquiring Phelps Dodge in 2007. Munk guided ABX to its major copper holdings at Lumwana in Zambia, Zaldivar in Chile and its gold mining and E&D properties held under separately traded African Barrick Gold whose output rose and costs fell in 3Q with adjusted net earnings of $39 million but has been for sale in the recent past. Munk's quest also led to acquisitions like Equinox, an African copper site later written down for $3.4 billion, and a promising project at Reko Diq in Pakistan that foundered in that State's self-confounding nationalism.
A potential disaster at its rich, very low cost Pueblo Viejo site (owned 60-40% with Goldcorp (GG)) in the Dominican Republic was averted this spring when ABX and GG agreed on a 51% tax & royalty package front-loaded to benefit the government of Daniel Medina (and presumably the people of the Dominican Republic). Production began last January and export from Pueblo Viejo began in May. 1H 2013 output was 213k gold oz. from proven reserves of 15 million oz.
Most of the negative excitement since early spring has centered on ABX's world-class gold and silver site Pascua Lama, high in the Andes and straddling the border of northern Argentina and Chile. Although the glaciers supposedly melted from "global warming," Greenpeace roused up people in Copiapo district to fight ABX on behalf of keeping local glaciers immaculate. In April Chilean district judges and then the Supreme Court issued a stay on mining till ABX completed systems to contain tailings dust and protect water. Although ABX complied, began work on remedial and protective systems and hired two senior Chilean mining executives to interface with local folks and the government, every mention of the matter is reported as if the mine has been snuffed. In fact, Chile's high Court has ruled that the project can proceed when the water management work is complete which is expected by late 2014. Last week, before announcing its tender of shares and debt-reduction plan, ABX said it would suspend its work on the Argentine side of the site (which had continued) and it seemed that another perfect storm of negativity had hit. Pascua Lama has 676 million oz. silver reserves embedded in 18 million oz. proven and probable gold reserves.
However, the markets had positive views of Barrick's prospects and value. The shares, proffered at $18.35 were rapidly bought which is not surprising given that analyst estimates put ABX's short term price target between $17-$30/share with the most recent targets, like that of Deutsche Bank being at the high end of this range. The fall of the share price from about $20 toward the tender price was unsurprising but a patina of panic was added as the indices paused from their recent surge (S&P +7% in 17 trading days from the October 9 intraday low at 1646 to 1775 early on October 30) and PMs suffered their usual risk-off trade. The spread on the notes tightened Friday which should bring a sunnier outlook on ABX which is part of its strategy. The company also announced that it would consider selling a stake in Pascua Lama to China and, except for environmental work, suspend operations until the PM outlook improved. This is consistent with the emphasis on cost-cutting, reducing debt and increasing profitability initiated by Jamie Sokalsky, a CFO who became CEO and President on June 5, 2012.
It is noteworthy that ABX remains a major producer of copper, a remnant of Munk's grand vision and in any case an essential commodity. ABX's 1H 2013 copper output was 261 million lbs. from reserves of 13.9 billion lbs. There are an additional 10.3 billion lbs measured and inferred copper resource. Barrick reports its all-in production copper cost at $2.61/lb. Copper has been selling at $3.30-3.35 for a few months as China's PMI and plans turn upward and the global economy, both in Europe and the US is said to be steadying.
Suspension of mining development at Pascua Lama will save an additional $1-$1.5 billion in 2014 in addition to previous reductions of about $2 billion. These savings were announced last week in tandem with 3Q results which slightly outperformed targets: ABX had 1.85 million gold oz output, in line with its 2013 estimate of 7 -7.5 million oz at all-in sustaining costs of $916/oz. the lowest in the sector. Also declared was 139 million lbs copper production at reduced fully allocated costs of $2.16 / lb. These cost reductions and continued output partner with the recent sales of non-core, higher-cost assets of the Yilgarn South properties in Australia, of Barrick Canadian Energy and the closure of the Pierina development gold site in Peru. ABX also has put into "sleep mode" its Donlin Creek site in Alaska owned 50-50% with Nova Gold (NG) and which ABX would largely develop.
Taken together, the picture for ABX continues to improve as short term - mid-term development and scale of overall operations are pared down to reduce debt and bolster profitability going forward. Production is steady and still leads the sector by a wide margin: GG and Newmont (NEM), the latter the only PM miner in the S&P 500, have revenues 35% and 62% respectively that of ABX, their negative revenue growth is, respectively 7 x and 3x worse than ABX and their production costs are higher. GG and NEM revenues / debt are better but in other metrics ABX is a king that is deleveraging. While ABX's rating remains Baa2, its share tender will retire more than $1 billion in debt due in 2014 at rates from 1.75% to 4.87% and shift to debt due in 2023 and 2043. By that point there will be a new monetary and reserve system in which gold is likely to play a major role and USD denominated debt, as with 30-year fixed rate mortgages will be a benefit for those paying it off in radically depreciated currency.
Takeaways: Barrick Gold in the past year has reversed an expansive strategy to focus on cost control, selling non-core and higher cost assets and increasing mid to long-term profit, sustainability and shareholder value. Given the terms of the current tender, prices this month are likely to remain between $17.75 and $19 with the lower end, or any dips below it presenting buy-in points. As markets and funds grasp the mid and long-term positives of Barrick's move, prices will rise even as RBS Capital and the other underwriters gobble the tender at $18.35. ABX has about 42% of its operation in North America and most of that in the rich Carlin trend in northern Nevada, one of the five best mining jurisdictions in the world. Chilean mining executives, Marcelo Awad and Eduardo Flores will help Pascua Lama proceed when regulatory issues are completed and bullion prices rise: it is likely that they will rise significantly even if they remain below what currency devaluation (fiat debt creation) and strong demand might dictate.
Even without Pascua Lama in whose development Chile has a strong stake (as do Chinese, Indian, Turkish and Russian buyers), ABX would be a profitable, high producing company. Skittishness induced by the current tender of shares and thoughts that Pascua Lama might be shelved, a strategically valid option unlikely to prove necessary, increased the appeal of what already was a strong value play.
Keep in mind PM sector volatility and your time horizon for retrieving cash. The direction and emphasis for ABX suggest it is stripped to its core strengths and situated to rise steadily. Even if global economies stumble, the appetite of Asian sovereigns and individuals for gold is unlikely to abate. In addition, Western depositories must replenish their stores. This is the background of a bullish case for ABX as a value buy. Its de-leveraging and debt reduction strategy embodied in its sale of non-core assets and last week's share tender suggest that the decline that began 4Q 2011 indeed bottomed the first week of July and that the company is in a phase of strengthening and incipient accretion.
Additional disclosure: I own shares in PM companies separately and in diversified funds.