- Barrick's weak stock quote the last six months has opened a strong buy opportunity for intelligent investors.
- Valuations on free cash flow and operating income are absurdly low vs. a U.S. stock market near-record overvaluations.
- Negative real interest rate spreads are widening, a huge positive for gold assets going forward.
I have not owned Barrick Gold (NYSE:GOLD) in many years, until last week. The main reason I have avoided shares in one of the leading gold miners in the world is other producers have looked more appealing. Alternative mining choices have been less expensive in valuation, with better growth prospects and stronger balance sheets. Well, the company has made substantial progress cutting costs and paying down debt the last two years, while the stock quote has underperformed, especially in late 2020 and early 2021. The fact Barrick also extracts around 450 million pounds of copper annually ($1.8 billion in revenues at current spot commodity pricing and 15% of total sales) is another positive argument for ownership that may not be properly discounted by Wall Street. The end result of all the moving parts is Barrick has morphed into a top "value" play in the mining sector into April.
Image Source: Company Website - Nevada
Over the last year, I have mentioned Newmont Mining (NEM) here, Pan American Silver (PAAS) here and AngloGold Ashanti (AU) here as being my favorite majors in the gold/silver mining arena. Today, I am adding Barrick to this elite mix of names for investors. Specifically, an industry low price to free cash flow ($3.4 billion in 2020 FCF) and operating earnings setup is screaming the company should now be viewed as a "must own" in the sector.
Cutting Costs and Slashing Debt
The latest Q4 earnings report highlighted improving trends in cash costs, all-in-sustaining-costs (AISCs), declining debt totals ($2.2 billion in net debt reduction for 2020 alone), and relatively steady management expectations for even better numbers between 2021 and 2024. In addition, the major gold miners as a group are now profitable enough (following a $500 climb in gold prices the last 3 years) to start returning capital to shareholders through stock buybacks and cash dividend raises. Barrick is working on a special $0.42 dividend to be paid in 2021 on top of a regular $0.09 regular quarterly payout. Below are some slides from the management presentation to analysts and investors.
Image Source: 2020 Q4 Presentation
The 2020 Annual Report does a nice job of graphing the drop in production costs for gold and copper the past two years, with estimates for 2021.
Image Source: 2020 Annual Report
Near 5-Year Low Valuation
Believe it or not, after a number of price swings in gold and copper, hot and cold feelings by investors, and flight-to-safety money flows last year, Barrick is now trading close to a 5-year low valuation on trailing 12-month results.
A variety of fundamental ratios illustrate the bargain valuation for the stock, a particularly strong buy if metals prices continue to move higher in 2021. Below is a chart looking at four basic fundamental valuation ratios for Barrick. Price to trailing 12-month free cash flow, operating earnings, accounting cash flow and total sales are each near a 5-year low in April.
However, this historical comparison against past valuations is only half the story. The other half is Barrick's current investment proposition on cash generation is approaching the cheapest in the sector right now, especially if you consider mining reserves and resources are long-lived in the 20 to 30-year range. (Barrick's "proven" reserves are 15 years for gold at the current mining rate, and 25 years for copper.)
Below are graphs comparing the company's free cash flow and operating earnings valuation to six of the top gold (and silver) producers in the world. The peer group includes Newmont, Pan American, Agnico Eagle (AEM), Kirkland Lake Gold (KL), Newcrest Mining (OTCPK:NCMGF) (OTCPK:NCMGY), and AngloGold Ashanti.
I estimate price to cash generation multiples of 15-20x are more appropriate for gold miners, with shorter-term interest rates near zero around the globe, using 30-50 studies of the gold mining industry's valuation against existing interest rates. Then, after considering the average U.S. equity is selling for equivalent cash generation multiples around 20x currently, Barrick could be a real bargain at 8x to 11x!
More good news for shareholders, a climbing GAAP earnings forecast from lower costs is anticipated, without any upside help from gold/copper selling prices.
A trailing dividend yield of 1.6% vs. a forward rate closer to 4% is now the expectation in 2021 (regular quarterly $0.09 payout with a special proposed amount of $0.42 paid from non-core asset sales in 2019-20). Compared to the S&P 500 equivalent rate of 1.4%, the major gold miners have become superior bargains for both income and safety-minded investors. Trading gold miners for 35 years, I cannot remember a similar period when the precious metals group was sending out cash distributions well above the prevailing U.S. stock market rate!
The bad news of sliding price for holders of Barrick the last year is today's good news for buy trade orders. The stock has underperformed the precious metals mining sector, as its quote got a little ahead of events on the ground. Barrick overshot improving results, as gold optimism during the summer of 2020 reached for highs not seen since 2012. Several mine issues, like temporarily closing the Porgera asset, also brought in selling not witnessed at the other majors.
Below are charts of the rotten 6-month total return performance for Barrick against the peer group, and the more industry-normal return over a longer 3-year span.
Below is another 3-year chart of daily price and volume changes. Nothing extraordinary to highlight, except for the oversold 14-day Money Flow Index situation. Rising from early March's most oversold level since the important 2018 bottom in gold, marked with green circles, the worst selling pressure in Barrick could be ending. If this is the case, prices around $20 in early April could be a terrific entry point for new investment.
Note: despite sharp underperformance of the gold mining industry and the overall U.S. stock market, Barrick has still gained better 11% better than the S&P 500 since 2018. If my bullish views are correct, another stretch of 1-3 years of market index "outperformance" could play out.
Why invest in gold? The quick answer is gold has proven a top counterbalance and hedge against inflation and financial market uncertainty. For 2021 specifically, declining real interest rates (adjusted for inflation) during the summer and fall months could cause a rush of buying interest. Below is a chart of 1-year Treasury yields minus the trailing CPI rate, pictured from 1971 to 2019, before COVID-19 appeared. Basically, when interest rates are far underneath inflation, the dollar's long-term worth is put into question. You can review for yourself how well gold performs when real interest rates are negative.
Image Source: Sunshine Profits Article
I wrote a story last month here explaining how far behind inflation and nominal GDP growth expectations, the interest rate picture in America has become. Below is an 18-month chart comparing 1-year Treasuries against trailing CPI. The present -1.6% rate is quite bearish for the dollar's worth historically, but about to get MUCH worse.
With easier inflation comparisons coming down the pike, Wall Street economists are looking for trailing CPI rates above 3.5% by the end of summer. Plus, the Federal Reserve is promising NOT to raise short-term interest rates until 2022, at the earliest. Translation: it is entirely possible negative interest rates of -3.5% to -4% will be reality in the fall. This would be the worst-case scenario for bond holders and foreign owners of U.S. dollar assets since the 1970s. When real interest rates turned negative in 1973, gold exploded from $50 an ounce to a peak around $800 in early 1980!
So yes, owning gold assets in April 2021 is a sound investment/speculation idea by itself, if not a requirement for your portfolio's diversification. Barrick is undervalued and highly profitable at $1,700 gold quotes. If gold is approaching another run to all-time highs from the ongoing dive in real interest rates, a Strong Buy rating is fully supported by math and logic.
I purchased Barrick last week, and may add to my position in the coming days. A fair value target of $25-30 today is completely justified by 5-year and 10-year studies of the basic fundamental valuation ratios mentioned in this article. How high can Barrick go? That's a question largely to be answered by gold and copper prices. If we are in the early innings of a dollar exchange rate tank (devaluation), $2500-3000 gold and $5-6 copper in 2022-23 may be our future. Using these prices, Barrick could be worth $40-50 a share, assuming interest rates do not change in a material way from today.
I wrote an article last month on the trading sentiment reasons to expect a short-term bottom in gold. The bullish arguments to hold gold have not gone away, despite what CNBC or the WSJ are reporting to the masses.
What are the downside risks? More of the same problems witnessed since August. Lower gold/copper prices would be the biggest drag on Barrick's price and valuation. A secondary concern is its significant ownership of mines in developing nations that could translate into higher income/sales tax rates, export taxes, mine closures like the Porgera situation, or even local government asset takeovers as remote possibilities. From my experience, the drop from $30 to $20 a share may have already discounted a host of future potential operating issues. As long as the gold/copper commodity price trend remains higher, I am confident Barrick will soon resume its long-term upswing.
Thanks for reading. Please consider this article a first step in your due diligence process. Consulting with a registered and experienced investment advisor is recommended before making any trade.
This article was written by
Analyst’s Disclosure: I am/we are long GOLD, NEM, PAAS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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