Description

Barrick is a LONG because:

• A recent (futures driven) drop in gold prices has caused ABX stock to plunge.  Any normalization in gold prices should provide upside.
• The new CEO is pursuing cost cutting and return maximization strategies
• The potential resolution of problems at 2 major mines – Pachua Lama and Pueblo Viejo – should provide upside from where the bearish sentiment currently stand. 
• The stock is at historic price lows and 4x EBITDA.

Company:  Barrick is the largest gold company in the world, by reserves, market cap and production. 

The company produces approximately 7mn ounces of gold and 500mn pounds of copper per year.  Its recent SEC reserves and resources were:

In the past 10 years, Barrick has grown its revenue at a 22% CAGR, to $14.5bn in 2012.   Gross margin has averaged 49%.  EBITDA has grown at nearly 24% compounded, with an average margin of 42%.   For the next several years, consensus has Barrick earning around $3.8bn per year in net income. 

The Stock:  Despite a 7-fold increase in the price of gold off the bottom, the gold mining stocks have generated little reward for their owners.  Barrick is no exception:  since its 2003 bottom, the total return on Barrick stock (including reinvestment of dividends) has been approximately 3% compounded. 

The Recent Sell-off: 

Within the past few weeks Barrick’s stock has been cut in half for several reasons:

• There has been a fairly quick 12-15% decline in the price of the metal to below $1,400.  On April 15, in fact, the single day drop in gold was the most in 30 years.
• Given that price decline, seemingly permanently bullish equity analysts are stepping over themselves to cut their ratings on Barrick and the entire sector.  For example, on April 22, the Deutsche Bank analyst said that Barrick’s NAV would actually decline even if the price of gold recovers to $1,500 an ounce where it had been a mere week earlier. The analyst also cut his price target in half.
• The analysts and the market seem to assume that the current gold liquidation will last forever.  From what we can tell, the recent price moves have been driven as much by margin calls on gold speculators and traders as anything fundamental.
• Specific to Barrick are concerns about the Pascua Lama and Pueblo Viejo mines discussed below.
• Another, not unreasonable, fear in the market seems to be that the companies will try to make up for price with volume.   The sector clearly has a history of value destruction in which the miners will continue to dig unprofitable holes and issue equity below NAV to open up mines at or above NAV.

We believe that any lift in the price of gold would provide upside for the stock.  We note that, until the recent decline, gold had remained above $1,500 an ounce since mid-2011. 

Opportunities at Barrick specifically:

We think Barrick in particular offers an interesting opportunity, since its new CEO, Jamie Sokalsky, seems much more focused on shareholder value creation than many others in the space. 

Sokalsky was appointed in June 2012.  Barrick’s legendary founder and chairman, Peter Munk, is still there. 

Prior to Sokalsky’s appointment, Barrick had a produced a mixed bag of results.  Certainly, the company had increased production, revenue and profit significantly over the past decade.  At the same time, there were several bumps in the road.  For instance, the company took multi-billion write-offs of both hedging contracts and of part of its Equinox acquisition.  Barrick’s stock price return clearly reflected that mixed bag of results. 

Turnaround in Place at Barrick:

We believe that Sokalsky shows the signs of a manager who will surprise to the upside in the coming years.   We think he is significantly more shareholder focused than we might expect (he has been with the company since 1993). 

In the last year, Sokalsky has taken a number of steps to improve profitability and returns at Barrick:

• Cutting production target in 2016 from 9mn ounces to 8mn, ridding them of unprofitable volumes
• Cutting $100mn in overhead
• Putting various lower-return assets up for sale (3 mines in Australia, Barrick Energy, ABG (although that sale fell through),  Kabanga nickel project in Tanzania)
• Changing management incentive compensation to be more in line with returns and profitability
• Committing to not opening any new mines beyond what they have planned now

Earlier today (April 24, 2013), the company reported earnings that beat analysts’ estimates.  Notably, the company has taken steps that support the idea of a turn around in place.  While maintaining their production guidance, ABX actually cut their exploration spending and capex guidance.  We view these as good signs that the management continues to focus on generating shareholder value. 

Optionality on the Pueblo Viejo and Pascua Lama Mines:

Barrick has 2 mines that will be important contributors to its future production:  Pubelo Viejo in the Dominican Republic and Pascua Lama in Argentina/Chile.  They are both very low cost, long-lived mines that should help maintain (or even grow) Barrick’s production and lift its overall profitability.  Both have recently run into controversy with the local governments.    We believe the stock can rally should the company show more clarity on either of these situations. 

Pascua Lama

Pascua Lama will add 800,000 ounces to annual gold production (at $0 cash cost) – 10% of Barrick’s total production.  It is supposed to open in 2h14.  Recently, the company has run into problems over both water rights and property rights in Chile.  The company has sunk almost $5billion into the mine and has another $3-4billion to go so any delay or cancellation would be a disaster.  Construction continues on the Argentine side of the mine. 

Pueblo Viejo

Pueblo Viejo should add 500-650,000 ounces in 2013 production, also at low cash cost.  The Dominican President Danilo Medina recently said that Barrick’s contract was unacceptable and must be changed

While it is impossible to predict the outcomes in either case, Barrick has plenty of experience in operating and developing mines in tough political climates and we expect that these situations will prove to be no different and will eventually be allowed to operate after the political shakedown is addressed. 

2013 Guidance:

• Production of 7.0-7.4mn ounces of gold at $1,700 per oz
  • Each $50 in the gold price hits EBITDA by $350-370mn
  • Production of 480-540mn pounds of copper at $3.50 per lb
    • A $0.25 drop in copper prices hits EBITDA by $60-70mn
    • A $0.25 rise in copper prices improves EBITDA by $120-130mn
    • Capex of $6bn  (revised down with 1q13 earnings to $5.45bn)

Consensus:

• Revenue of $14.5bn
• EBITDA of $7.5bn

Low Valuation:

At current levels you are buying the stock for just over 4x EBITDA, 5x 2013 earnings and a 5% dividend yield – assuming some mean reversion of gold prices.  Even assuming that gold prices remain around $1,400 and Barrick’s EBITDA gets hit by $2bn (this assumes that the sell-side had baked a $1,700 gold price into their assumptions, which seems high), the company still trades under 6x TEV to 2013E EBITDA. 

At $18.60, Barrick is still trading near its recent and multiyear lows while gold itself has been rallying for days. This trend cannot continue.   While the stock is up today on earnings, we expect significant further upside in the coming months. 

At March 31, Barrick had $14.7bn in debt versus $2.3bn in cash.  While there have been noise about credit downgrades and Moody’s did put the company on watch, Barrick is still investment grades and its various tranches of bonds still trade tight to treasuries.   The company believes it can cover dividends, capex and debt service out of cash on hand and its credit facility.  

Tactics:

We would also just go long Barrick as this should work on an absolute basis.  For the faint of heart we would recommend shorting the GLD dollar for dollar against ABX. 

I am not a gold bug and do not think of it as some mystical object but do believe that is has always functioned as a form of money and ABX looks like a way to hedge Bernacke helicopter risk as well and buying a cheap yielding stock.

Catalyst

• Gold stabilizes and eventually goes up

   

• Resolution or clarity on Pascua Lama and Pueblo Viejo