If you have not read Part I of my analysis, or would like to review it as a refresher, it can be viewed here.
How to Value Barrick:
Barrick (ABX) is the largest gold mining company in the world. Future production and operating expenses are fairly predictable; therefore the most appropriate way to value Barrick is by using a discounted cash flow analysis. Although the DCF is the most common way to value a mature company like Barrick, the following analysis will also value the company using a "back of the envelope" calculation, the Graham valuation, and a PE multiple analysis to obtain a better grasp and certainty of Barrick's intrinsic value.
Q1 2012 Earnings:
Barrick reported solid Q1 earnings that came in at $1.03 per share. My 2012 earnings forecast are relatively conservative at $3.63 per share, which I expect the company will be able to achieve. The major driver for Barrick's Q1 earnings vs. my forecast was that they were able to obtain an average gold price of $1,691 compared to my full year estimate of $1,600.
Next Generation Projects:
With multiple mines at all stages of production, Barrick should be able to continue growing into the foreseeable future.
Back of Envelope Calculation:
As a quick valuation calculation, total future earnings are estimated by multiplying P&P gold reserves by the projected gold price, and the estimated net profit margin. Dividing by the number of shares outstanding results in the total projected EPS obtainable from the current reserves, which values Barrick's stock at $64.83 per share.
Note: This does not account for future reserve growth/replacement, the time value of money, or required CAPEX in excess of depreciation.
The Graham valuation is a good estimate of intrinsic value for mature companies with stable growth. To reach the intrinsic value of $61.45 per share Barrick's stock price would have to appreciate 62%.
DCF with Terminal Value:
A DCF with a terminal valuation calculation is the most common DCF valuation, which assumes the company will continue to grow past 2016, although at a slower rate than their current growth rate. CAPEX is projected to be $5.7B in 2012 and grow at 10% per year through 2016. After 2016 it is assumed that Barrick will grow operating cash flow at a conservative 4% per year, and return on capital will decline to 6%; resulting in a required reinvestment rate of 67% of operating cash flow to maintain its growth. The resulting FCF in 2017 is $2.6B. Assuming a long-term WACC of 7% and a growth rate of 4%, results in a terminal value of $87.9B, which has a present value of $70.5B. Adjusting for net debt, Barrick's investment in securities, and equity in investees, results in an equity value of $60.0B, or $59.97 per share.
P/E Multiple Valuation:
Valuing the company using Graham's fair P/E ratio indicate Barrick should trade for $52.64 per share, using conservative growth and 2012 EPS estimates.
Using multiple valuation estimates adds to the strength of the DCF valuation, and indicates with reasonable confidence that Barrick is worth between $52.64 and $64.83 per share. Splitting the difference between the high and low estimate results in an implied intrinsic value of $58.74 per share.
- Since Barrick does not hedge, their revenue is exposed to the volatile price swings of gold and silver.
- Extended delays at Pascua-Lama could hurt their earnings, growth prospects, and balance sheet.
- An inability to obtain new productive mines would significantly hurt the company's future prospects.
- Natural disasters or poor weather conditions at one or more of Barrick's major mines could damage or prevent continued operations for an extended period of time.
- Potential government or environmental regulation could impair profitability.
- Reserves and future production are estimates and subject to change.
- Barrick is spending almost all of its operating cash flow on CAPEX to expand its annual gold production.
- P&P reserves have not grown in recent years.
- If CAPEX not invested in productive mines with strong return profiles the company could suffer.
- If India takes strong action to limit gold imports, the price of gold could suffer a significant near-term setback.
- Barrick's market price is not appropriately valuing its current reserves and stable growth prospects. The current stock price as of June 22th, 2012 is $37.92. However, using a conservative estimate for sustainable growth after 2016 of 4% per year and a reduced stable period return on capital of 6%, values the company at $59.97 per share.
- Having multiple valuations methodologies that estimate the company's intrinsic value within fairly tight range increases the strength and the probability of having an appropriate fair value estimate.
- Analysts are currently forecasting respectable earnings growth through 2013.
- Gold production over the next 5 years is expected to be relatively stable, with only two major mines beginning production (Pueblo Viejo and Pascua-Lama).
- Only selling 25% of Pascua-Lama's projected silver production to Silver Wheaton (SLW) leaves Barrick with significant exposure to silver's potential price appreciation.
- Being well capitalized, having $2.7B in cash, and a $3.0B undrawn revolver allows Barrick to continue gold production growth without the need for new financing. Having the only "A" rated balance sheet also reduces the possibility of future share dilution and helps ABX weather any downturn in the credit markets.
- Being unhedged allows ABX to take advantage of the historical trend in precious metal price appreciation, as real interest rates continue to be negative for the foreseeable future, and the Fed planning to keep interest rates at historic lows until at least late 2014.
- Strong demand from China and India create a bullish case for precious metals.
- Barrick's dividend shows a commitment to rewarding shareholders and gives investors the opportunity to benefit from price appreciation of the stock, as well as future dividend increases.
- Gold miners are cheap relative to the price of gold, as currently indicated by the Gold/XAU ratio at 10.05:1.