In the Barrick Gold (ABX) 2011 annual report, President and CEO Aaron Regent noted that (pdf) while the value of the oldest gold bullion ETF - the SPDR Gold Trust (GLD) - had increased by 260% since the ETF went public in 2005. Barrick's net income had increased by 900% and operating cash flow was up by 500%. Unfortunately for Barrick Gold shareholders, the share price has gained only 72% over the seven year time period and investors have picked up another 10% or so in dividends. One way to look at the under-performance by Barrick shares is that there is a significant amount of unrealized value in the company's gold mining operations.
As the world's largest gold mining company, Barrick benefits significantly from economies of scale. The company's cash production cost per ounce of $460 in 2011 was one of - if not the - lowest in the industry. In comparison, the second largest gold mining company, Newmont Mining (NEM) reported a cost of $591 per ounce in 2011. Gold Corp (GG) - considered to be one of the most efficient gold producers - reported cash cost per ounce of $534 for the year. Going into 2012, cost for the mining companies are expected to increase somewhat dramatically - at least $100 per ounce - and the cost advantages of Barrick Gold may turn out to be significant, depending on what happens with the price of gold.
The combination of very good growth numbers in 2011 - revenue up by 30% and adjusted net income up by 33% - and a declining share price over the last year has left Barrick Gold trading at just 8.3 times the consensus 2012 earnings forecast. Newmont Mining, which is forecast to earn a similar amount per share trades at 10 times the earnings estimate. Newmont's higher valuation may be due to a higher dividend payout. Barrick is currently paying 60 cents per share annually for a 1.5% yield and the Newmont dividend is at $1.40 per year, putting the yield at 3%.
Barrick Gold has several new and expansion projects coming on line in 2012 and 2013. Production measured in ounces will remain flat in 2012 with a forecast range of 7.3 to 7.8 million ounces compared with 7.68 million produced in 2011. Longer term, the company expects to produce 9 million ounces per year by 2016. Copper production is forecast to increase by about 25% in 2012. Silver is becoming a focus of the company. There are no production forecasts for 2012, however, in the annual report the company stated it expects silver output to grow from 3 million ounces in 2011 to 50 million ounces in 2016.
The investment scenario for Barrick Gold focuses on the company as the low cost producer in the sector and that the share price is undervalued as indicated by the low price-to-earnings ratio. If the price of gold has entered a trading range resembling the $1,500 to $1,900 where the metal has ranged for the last 10 months, Barrick should be able to put up better net results than the other mining companies. Once the market realizes this a company that can build value when the price of gold is not increasing, the share price should be bid up out of the single digit P/E territory. An earnings ratio of 10 based on the 2011 earnings results would push the Barrick share price 17% higher than where it currently trades. Throw in a little profit improvement and investors could be looking at a 20% gain in 2012 - assuming flat results for gold. One area where the Barrick Gold board of directors could help shareholder value would be to declare a boost in the quarterly dividend. The company has steadily increased the dividend, but the current payout is just 13% of net income. Paying out 25% of the net - almost doubling the dividend - would definitely make this stock more attractive to investors, giving a further boost to share value. However, looking at past history, a 25% increase to 75 cents annually is more likely.
The assumptions here point to Barrick Gold as an attractive investment candidate if gold remains flat through 2012. Past this year, the expected production growth should be positive for the share price in both a flat and rising gold price environment. Obviously, for investors who think gold will decline, gold mining stocks should be avoided. If the price of gold moves strongly higher in 2012, a bullion ETF investment is probably the best investment choice. Since the future is difficult to predict, a split investment of Barrick Gold and a bullion ETF is a conservative way to give a portfolio the best chance of attractive profits from the gold market in 2012.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
