When Barrick Gold Corporation (ABX) named Jamie Sokalsky as the new Chief Executive Officer last June, the company took a significant step towards the next chapter in its history. The major mining companies, including Barrick, Kinross Gold (KGC), AngloGold Ashanti (AU), Newmont Mining (NEM) and Goldcorp (GG), have been on the "grow gold production at all costs" path for an extended period. With the price of gold skyrocketing, this approach could be justified to investors. Lately, however, as the price of gold has remained range-bound between $1,550 and $1,650, investors have become dissatisfied with the approach. This was very clearly underlined in Barrick's most recent earnings release - detailed below - in which costs played a significant role in a significant earnings miss. As Barrick's new CEO looks to steady the proverbial ship and changes the focus to discipline and potential asset sales, Barrick is the best name to own at current levels.
A New Era of Discipline
Where late July saw rumors that Barrick was considering an acquisition of Kinross Gold, since the early-August earnings miss, these rumors have all but disappeared. Instead, Mr. Sokalsky has stepped to the forefront of his company's public image and delivered his message in a clear and concise way: "Going forward, returns will drive production. Production will not drive returns." During the price run-up of gold, many of the majors were in full-blown production growth mode, throwing money at projects that were believed to be sources of new ounces.
The good news for Barrick in this department is that as of 2011, the company is the world's largest miner of gold as measured by production. What this means is that the company is able to pull back the reins significantly without the same constraints as smaller rivals. Barrick has built a sizable lead and will now be able to enjoy the fruits of that labor by offering investors a more disciplined approach moving forward. This should not only pay handsome rewards to the company, it gives investors the opportunity to participate in a more measured approach without the concern of insufficient production.
Another dramatic step that offers evidence that the company is entering into a new era is the recent announcement that it has begun talks to divest certain assets. It is of particular importance to be precise in what has and has not happened to date because the rumor mill has begun to churn and many would-be analysts have completely 'bastardized' the story. Recently, Mr. Sokolsky and Barrick announced that the company had entered into early discussions to sell its stake in African Barrick plc to China National Gold Group Corp. In a prime example of how the internet knows everything and nothing simultaneously, the story has been morphed into a rumor that either the China Gold Group, or perhaps the Chinese government, is considering the entire company as an acquisition target. This is not the case in any way, and yet after one report misrepresents the facts, if you'll pardon another cliché, it's off to the races.
Returning to the facts, the news is of sweeping importance for investors because, in addition to serving as a symbol of a new chapter, the addition of significant asset sales should have a profoundly positive impact on the company's bottom line. This asset in particular makes a nice divestiture for Barrick when one considers that in 2011 the company produced 7.7 million ounces of gold with an average cost of $460 per ounce. The production contribution from African Barrick was 509 thousand ounces that came at a cost of $692 per ounce. As is discussed below, costs have been a real problem for the company.
An Earnings Miss
When the company announced that it had significantly underperformed analysts' expectations in its most recent earnings report, cost was a significant factor. The report specifically pointed to cost overruns at Barrick's Pascua-Lama mine in South America. The expected total cost of the mine was increased to $8 billion from the initially estimated $1.5 billion. Coupled with other cost concerns, the company immediately came under fire.
Despite the explosion in costs, the metrics for Barrick are still extremely appealing and make a strong case that it is the strongest company in the sector. The company is currently trading at a trailing price-to-earnings (P/E) ratio of 8.8 relative to 101.6 for Newmont and 1010 for AngloGold; Kinross failed to earn a profit for the reporting period. Even with the Barrick's newly-announced philosophy of restraint, the company has excellent growth expectations as reflected by the price-to-earnings over growth (PEG) ratio. Barrick has a PEG of 0.11 relative to 0.13 for AngloGold, 0.16 for Newmont and 1.17 for Kinross. If the company is able to become more focused while still achieving this type of growth-adjusted valuation, it should prove very favorable for shareholders.
Another strong positive for the company is the operating margin it was able to achieve in spite of the cost overruns. The company boasts an operating margin of 42% relative to 38% for Newmont, 32% for AngloGold and 31% for Kinross. With this type of margin in place, one is forced to wonder if the analyst expectations that the company missed were 'priced-for-perfection'. In any event, the company looks extremely solid at current levels.
Overall, while there are widely conflicting views over where gold will go for the rest of the year, a prudent investor will maintain exposure to the sector. For this purpose, Barrick is the strongest candidate. With the combination of strong metrics and a new management direction, the company shows great promise as part of one's portfolio.