After an unambiguously terrible 2013 that saw Barrick Gold (ABX) write off $11.5 billion in assets, some investors are hopeful that the worst is behind the company after a recent equity offering and decent quarterly results. In the most recent quarter (available here), the company earned $0.37 on a continuing basis (impairments continue to riddle results) with adjusted operating cash flow of $1.09 billion. While Barrick has moved out of crisis mode thanks to a painful equity offering, the stock is still exceedingly risky as the company deals with acquisitions and expansionary projects done during the boom years that are no longer economical today.
In the fourth quarter, Barrick produced 1.7 million ounces of gold and sold 1.8 million. For the full year, it produced 7.17 million ounces, but it expects to produce far less in 2014, around 6-6.5 million ounces. With lower gold prices, Barrick has been forced to retrench, shutter operations in more costly, low-grade areas, and suspend development in other mines like the Pascua Lama project. These cost-saving initiatives are the driver of lower production guidance. With gold at roughly $1,300, it cannot afford its previously massive cap-ex budget.
In fact after spending $1.3 billion in cap-ex last quarter for total 2013 spending of $5 billion, Barrick plans to only spend $2.4-$2.7 billion this year. This decline is mainly due to the suspension of activities at Pascua Lama. With its high debt load (more below) and lower selling price, Barrick has been forced to suspend some expansionary efforts. While this could dent future growth if gold prices rebound, Barrick is forced to prioritize cash accumulation at this time.
Unfortunately, it is increasingly expensive to mine gold. Even though the company will focus on lower cost operations, all-in sustaining costs will rise to $920-$980 from 2013's $915. Assuming an average selling price of $1300, Barrick will deliver an all-in sustain cash margin of about $2.19 billion. After factoring in growth cap-ex, I expect Barrick to generate less than $500 million in free cash flow this year with earnings power of $1.20-$1.35. Even with a slashed cap-ex budget, Barrick is not generating much excess cash and remains very vulnerable to a downturn in the price of gold.
Even after issuing $3 billion in stock to pay down debt, Barrick still has a debt load of $13.08 billion, down only slightly from last year's $13.94 billion. Further thanks to write-offs, its shareholder equity account lost $8.6 billion in value to $16 billion. Even with the equity offering, the company's debt to equity ratio worsened in 2013 to 82% from 57% last year. In other words, Barrick still has a debt problem.
Barrick's debt pay-down solved the firm's liquidity problem as it now only has $1 billion maturing in the next four years. However, its long term debt problem is really no better than it was one year ago. While investors don't have to worry about a bankruptcy filing or cash crunch for the foreseeable future, debt problems 5-10 years from now remain present. Without substantially higher cash margins (which would require gold to go on another sustained bull run), Barrick will struggle to pay down the debt load without issuing new equity at some point in the future. Barrick's balance sheet is far from repaired. Liquidity problems are fixed but long term debt problems persist.
Further, Barrick was forced to reduce its reserve estimate to reflect lower gold prices. It currently has reserves of 104.1 million ounces compared to 140 million last year with a new assumed gold price of $1,100. Now if gold prices do spike higher, Barrick could mine some of those 36 million ounces it has lost. However if prices stagnate for a prolonged period of time like 1981-1996, Barrick may not be able to recover those lost reserves. Using the new reserve figure and assuming constant cash margins of $350 and 5% production growth, Barrick's reserves have a present value of $22.36 billion. For comparison, ABX has a market cap of $23.7 billion. When you factor in the eventual repayment of $13 billion in debt, fair reserve value is roughly $15. Even if investors used the old reserve figure and a higher average cash margin of $400, the present value of reserves would be $30 billion or about $20 per share after accounting for debt.
Even under a best case scenario, Barrick is only worth $20, right where shares are trading now. Shares are fully pricing in any good news. Gold prices will need to rally another $200+ to provide enough upside to offset the risks posed by declining production in 2014 and a large debt burden. With tame inflation in the U.S. and little risk of a Euro break up, the bull thesis in gold is questionable. Further, the Fed is pulling back stimulus, which minimizes gold's value as a play on liquidity and cuts the likelihood of high inflation. With gold likely range bound around $1,300, Barrick's debt load will hold back results, and many supposed growth projects will be too costly to pursue. Fair value is likely somewhere in the $15-$17 range. Investors who want to be long gold miners should focus on one with a better balance sheet like Agnico-Eagle (AEM) or Goldcorp (GG). Barrick remains very risky, and investors should sell and look elsewhere.