I have stated it before and I will state it again: Barrick Gold (ABX) is a "Hedging Miracle." I anticipate that lower-than-anticipated cuts to the government will pique ever-greater interest in gold as a protection against inflation. The fear over runaway spending will naturally attract entry for many investors. With global expansion, a record of beating expectations, and major catalysts ahead, Barrick offers favorable risk/reward compared with competitors.
From a multiples perspective, Barrick appears cheap. It trades only at a respective 11.4x and 8.5x past and forward earnings, while New Gold (NGD) trades at a respective 21.6x and 15.7x past and forward earnings. The Street currently rates shares of the former a "strong buy" as opposed to only a "buy" for those of the latter. In my view, New Gold is between a "sell" and a "hold" due both to limited upward movement for its multiples and reliance on managerial execution. Although New Gold has a stellar management (as evidenced by Blackwater Project transformation), the atmosphere of confidence has set the bar, in my view, simply too high for an industry that offers limited control.
At the third-quarter earnings call, Barrick's CEO, Aaron Regent, noted strong production, strategy, and a commitment to returning free cash flow to shareholders:
"Overall, we are pleased with the results in the quarter. Operationally, we met our production and cost targets. Quarter 3 gold production was 1.93 million ounces at total cash cost of $453 per ounce. EBITDA's on track to meet our original guidance for 2011…
In September, we announced 2 new world-class gold discoveries, Red Hill and Gold Rush, which are close to our Cortez mine in Nevada, and we expect to significantly expand the initial 3.5 million ounce inferred resource. Rob will update you on this in a moment. With the growth in our earnings base and a positive outlook on the gold price, the Barrick Board approved a 25% increase to our quarterly dividend to $0.15 per share. This continues our track record of paying a progressive dividend, which has now increased by over 170% the last 5 years".
For the last 9 out of 10 quarters, the company has beat expectations and yet it still is nowhere near the multiples that New Gold is trading at. With a good degree of leverage to increase scale, the company has significant catalysts in Pueblo Viejo, Red Hill, and Gold Rush.
Consensus estimates for Barrick's EPS are that it will grow by 47.9% to $4.91 in 2011 and then by 22.4% and 9.3% more in the following two years. Assuming a multiple of 14x and a conservative 2012 EPS estimate of $5.40, the rough intrinsic value of the stock is $81.62 for 63.9% upside. Even if the multiple were to plummet to 9.5x and 2012 EPS turns out to be 10.1% below the consensus at $5.40, the stock would still not decline.
New Gold, on the other hand, has more aggressive growth estimates. The Blackwater Project has gone from a 4.2 Moz project to a 6.5 Moz project in around half a year - an incredible transformation. New Afton is anticipated to begin in the second half of 2012 and produce at a rate of 80Koz / year Au for the following five years of operation. While this development and successful past acquisitions makes the backdrop rosy, gross margins are still around 870 bps lower than that of Barrick's at 52.8%. Moreover, since the company is not as exposed to sovereign debt issues, investors do not stand to benefit as much from fear over runaway spending.
Consensus estimates for New Gold's EPS are that it will grow by 95.8% to $0.47 in 2011 and then by 44.7% and 29.4% more in the following two years. Assuming a multiple of 18x and a conservative 2012 EPS estimate of $0.61, the rough intrinsic value of the stock is $10.98 - implying virtually no upside. If the multiple were to decline to the standard level of 16x and 2012 EPS turns out to be 14.7% below the consensus, the stock would fall to $9.28. Accordingly, I recommend holding out on the stock for now.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in ABX over the next 72 hours.
