December 10, 2004
The Brave Owners of Barrick
By Brady Willett

Strange but true: ABX is up by nearly 50% over the last 7-quarters, but Barrick is earning less money today (per ounce) than it was when gold was trading at $323 an ounce. 

Over the last 12 months the $12.5 Billion Barrick has produced $169 million in net earnings, paid out $117 million in dividends, and produced negative free cash flow. Translated these numbers equal a trailing price-to-earnings multiple of 74, a dividend yield lower than Paychex (one of the finest long-term dividend achievers), and a cash flow trend that threatens the company’s pristine balance sheet. Taken alone these numbers are enough to give ABX shareholders nightmares.  However, of equal or greater concern is that Barrick, like all gold producers, needs to find more ounces simply to ensure its longer term existence.
 
ABX shareholders conclude that a rising price of gold will eventually solve overvaluation concerns, and that the company will be able to replenish and/or add to reserves with new/expanded projects.  As these speculations take a significant amount of time before being validated or annulled, some current trends are worthy of analysis. Warning: the current trends do not paint the current price of Barrick in an optimistic light.  
 
It Costs Money To Get Ounces Out of The Ground

Ignoring terms such as ‘cash costs’ and ‘total production costs’– these terms do not correlate to earnings and cash flows - in 2003 Barrick earned $36 profit per ounce (net income divided by ounces sold). With 85.9 million P&P ounces in the ground this means that Barrick is sitting on $3.1 billion in future profits.  Add $3.1 billion to the company’s current net equity position and you get $6.48 billion.

Does it make sense to pay $12.5 billion today (ABX’s market cap) for something that is going to achieve a total asset value of $6.48 billion over the next 15.6 years?

In response to these numbers some would point out that Barrick’s reserves are likely to expand, while others would quickly call the $36 per ounce profit figure ridiculously low.  There is no debate on the first point – Barrick’s expansion plans are extremely aggressive!  However, debate on the second point is not as easily resolved.

ABX - Quarter ended 3Q04 2Q04 1Q04 4Q03 3Q03 2Q03 1Q03 4Q02 Gold sold (thous of ounces) 1,267 1,222 1,247 1,362 1,505 1,395 1,292 1,540 Average spot gold price 401 393 408 392 364 347 352 323 Average realized gold price 395 372 382 394 365 352 355 343 Total production costs 307 297 290 292 265 274 285 267 Inferred per ounce profit* 88 75 92 102 100 78 70 76 Actual per ounce profit 25.26 27.82 20.85 56.53 23.26 42.29 22.45 35.06 CFO per ounce 119.97 88.38 101.04 98.38 124.25 44.44 101.39 126.62 Basic FCF per ounce -52.09 -66.28 -2.40 20.55 70.43 -5.01 50.30 86.36 * Average realized gold price minus total production cost estimate

Poorer grades and inflationary pressures have combined to increase Barrick’s total production costs per ounce by more than 15.85% over the last year (from September 31, 2003 to September 31, 2004). During this same time the company’s realized selling price has only increased by 8.22%.  Looking back a little further, Barrick made more money selling gold at $343 an ounce in 4Q02 - both per ounce and total net income - than they did selling gold at $395 an ounce in 3Q04.  Keeping the above $36 per ounce profit tally from 2003 in mind, Barrick has been unable to crack $28 per ounce in profits in the last three quarters.

Assuming Barrick can keep costs constant and achieve 2003 profit levels, the company will need to sell its 85.9 million ounces of gold at an average selling price of $505 an ounce to accumulate $12.5 Billion in total net earnings. As a potential shareholder this is ominous: $505 an ounce is required to simply get returned in the future the price you are paying for the company today…

Embellished...But

Barrick is not going to cease operations 15.6 years from now.  Rather, two of the company’s new developments – Veladero (to start producing in late 2005) and Pascua-Lama (2009) – could be all that is required to ensure that production slack from aging mines is compensated for. 

Nevertheless, what the above estimates do is help debunk speculations that there is an apples-to-apples relationship between Barrick’s earnings and the price of gold.  Similar illustrations of a earnings/price of gold disconnect can be made with Newmont and countless other producers.

The Truth About Barrick and Gold Stocks

Gold companies have execution concerns like any company; they need to buy/maintain machinery, pay back debt, pay laborers, deal with currency/interest rate issues, continually find more gold, etc. Accordingly, it is important to remember that a massive 584 million ounce silver deposit (Barrick’s Pascua-Lama) is not worth 584 million times the price of silver. Rather, it is worth the profits than can be made from mining the ounces (Barrick’s historical silver statistics are not clearly disclosed).

If Barrick was not producing respectable returns (compared to its stock price) when the company was selling gold for $395 an ounce do not assume that the company will make significantly better returns at $445 an ounce.  If you add $50 an ounce to Barrick’s per ounce profits from the third quarter you get total net income of $95 million. $95 million per quarter annualized is $380 million – which works out to more than 30 times earnings!

Many gold specialists ignore the fundamentals touting gold stocks as ‘must own’ because of crude ‘gold to the moon’ conclusions.  An analysis on Barrick suggests that it will indeed take a moon bound gold price before the company’s stock price begins to make sense.  In short, because the value investor searches for a high degree of safety, Barrick - a company with a solid portfolio of properties and long-term appeal - should only be owned at current prices by the brave.



Disclosure:  Todd and I previously owned Meridian Gold, Franco-Nevada (pre-takeover) and Barrick Gold.  We prefer to own the hard metal instead of the stocks today.