Barrick Gold African Unit's Slump And Uncertain Fate Weigh On Outlook

| About: Barrick Gold (ABX)
  • African Barrick Gold, a subsidiary of Barrick Gold, has declared its annual preliminary results. ABG is being closely watched due to fears that it will drag down Barrick Gold’s overall performance.
  • Net earnings were reported at $59 million, including impairment charges of $46 million on account of the Tulawaka mine closure. Earnings in 2011 were $275 million.
  • Lower profits were due to higher costs and lower production this year.
  • ABG’s results come in the backdrop of sales talks for the business with China National Gold breaking down.
  • ABG has now ordered an operational review at its mines to focus on increasing free cash flow generation. This will be done by reducing energy and maintenance costs, optimizing capital spending, and organizational restructuring.

African Barrick Gold (ABG), in which the parent company Barrick Gold (NYSE:ABX) holds a 74% stake, declared its annual preliminary results on February 13. The company reported net earnings of $59 million, including one-off impairment charges of $46 million on account of the Tulawaka mine, which is being closed in 2013. In comparison, net profits in 2011 stood at $275 million. Annual revenues declined to $1.1 billion from $1.2 billion year-over-year due to lower production, offset to some extent by higher prices.

ABG is being closely watched due to its potential to drag down the parent company’s earnings (scheduled to be released on February 14) as a result of poor operational performance throughout the year. Also, ABG was in the spotlight for the major part of 2012 due to talks with China National Gold to sell Barrick Gold’s stake in the company. Eventually talks broke down, ostensibly over the valuation of the assets. We believe that China National Gold was apprehensive about dealing with the operational challenges and hence, unwilling to pay Barrick’s asking price. Since then, an operational review has been ordered by ABG to improve efficiency and returns.

Higher Costs Drag Down Profits

Total cash costs per ounce of gold sold stood at $949 in 2012. This is a steep increase from 2011, when the costs stood at $692 per ounce. The main reasons were an overall decline in the grade of ore mined and higher energy and maintenance expenses. Ore is said to be lower grade when the percentage of metal is less in a given quantity of ore. Hence, the production of gold went down despite an increase in the quantity of ore mined, which by itself needed higher expenses. Higher energy expenses are a consequence of having to use diesel generators in absence of adequate power supply.

To put the cost figures for ABG in perspective, Barrick Gold is expecting total cash costs for 2012 in the range of $575-585 per ounce. This figure takes into account Barrick’s worldwide operations.

Sale Of African Barrick Gold By Parent Company

The primary reasons for Barrick Gold wanting to sell its stake in ABG are the poor performance of the African business, as well as problems Barrick faces in other regions of the world, which has caused capital to become scarce. Barrick’s African mines have faced problems due to security issues, illegal mining and power blackouts, leading to production shortfalls.

Due to the high cost of production, ABG doesn’t meet Barrick Gold’s criteria as far as rates of return are concerned. The company has adopted a policy of prioritizing projects that provide decent rates of return rather than those that result in the largest production by volume.

Also, talks with China National Gold over a possible sale broke down in the fourth quarter over the issue of valuation. Recognizing that it would face the same operational issues as Barrick Gold in operating ABG’s mines, China National Gold was apparently unwilling to pay the price quoted for these assets.

Operational Review

Falling free cash flows in the gold mining sector are discouraging investors. As a result, the performance of gold miners’ equities has lagged the performance of gold as a physical commodity. Therefore, the core focus of the operational review ordered by ABG is to drive free cash flow generation commensurate with the size and quality of its asset base. It would otherwise be difficult for it to unlock the true value of these assets in a sale.

The specific initiatives being undertaken to achieve this goal are operating cost reductions, measures to discipline capital spending, the simplification of its organizational structure, corporate overhead cost reductions, and the ability to deliver mine planning. In a nutshell, these initiatives will seek to find ways to reduce energy and maintenance costs, optimize spending on new and existing projects for maximum return, and come up with the right mix of local and international employees to meet production targets while reducing labor costs.

When Barrick Gold releases its Q4 earnings, we will be looking out for the top management’s comments on ABG’s results.

Our price estimate for Barrick Gold is $51, which we will revise once the results for Q4 2012 are declared.

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Disclosure: No positions.

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Tagged: , Gold, Canada, Earnings
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