Barrick Gold (NYSE:ABX), the largest gold mining company in the world, has been a disappointment so far this year. With the gold price up nearly 11 percent and the Market Vectors Gold Miner ETF (NYSEARCA:GDX) up over 20 percent, Barrick Gold shares are up a mere 10 percent. While a rising gold price is going to benefit the company and while the company claims that it has some of the lowest costs in the industry, there are reasons that I believe that Barrick Gold shares will continue to underperform the gold price.
First, Barrick Gold has an incredibly large debt load at over $13 billion. This has several negative consequences. First, if the company loses its cash flow due to lower gold prices or a mine shutdown, it can put the company into bankruptcy, which means the stock would be worth essentially nothing. Second, when Barrick brags about its low production costs, it does not include its interest obligations, which reached $800 million in 2013.
With 6.5 million ounces of gold production next year, that means that the company’s debt is adding roughly $123 per ounce of gold produced, which is a lot in this environment. While this number comes down when we consider that some of the cost of servicing this debt can be added to the cost of mining copper, the fact remains that Barrick’s debt load is adding to its overall production costs.
Second, Barrick Gold has been mining more and more copper and less gold. Gold production has fallen from about 7.3 million ounces to 7.2 million ounces year over year, and next year this figure is expected to fall to just over 6.5 million ounces due to divestitures of gold mines. On the other hand, copper production has risen from 472 million pounds in 2012 to 520 million pounds in 2013.
As a result, the company is seeing the weakness in copper prices impact its revenues and profits, and so long as copper prices remain weak, this is going to weigh on Barrick’s share price.
Third, last year the company issued 164 million shares. While it used some of the proceeds to pay back debt (the debt load was as high as $15.7 billion last year) the fact remains that there are more shares outstanding. Therefore each share represents a smaller portion of the company. Furthermore, given the increased supply of Barrick’s stock, these additional shares are likely putting pressure on the price. It is going to take a while for this $3 billion worth of stock to find homes among long-term investors, and so this increased supply will continue to weigh on Barrick’s share price.
Fourth, the company has been divesting quality assets. Last year it divested the profitable Yilgarn mines in Australia. Not only were these mines profitable, but Australia is one of the safest places to mine. Even when Barrick divested some of its higher-risk assets — for instance, a part of its stake in African Barrick, a mining company operating in Kenya and Tanzania — it does so at an inopportune time, when the share price was low, and it only divested a small portion of its holdings, at $188 million.
With these points in mind Barrick Gold’s underperformance is justified, and I think it is set to continue. The company needs to change its mindset to get me interested. Here are a few things that I will be looking for that would get me interested in Barrick Gold shares.
First, the company needs to reduce its debt significantly. This will be painful for current shareholders, but it will benefit the company longer term.
Second, the company needs to devote itself to gold and divest its copper and other base metal assets. While this is a personal preference given that I am bullish on gold and neutral to slightly bearish on copper, I think if Barrick does this its management will be able to show investors that it is a focused and disciplined company. Some of the company’s copper projects, notably the Equinox project, have been extremely disappointing and led to the destruction of shareholder value.
Third, the company needs to come up with a realistic growth plan. Gold production has been shrinking, and this is unacceptable for a company as large as Barrick. Barrick has the cash flow and the expertise available to make accretive acquisitions and to explore its vast land holdings in order to grow production.
In doing these three things, Barrick won’t turn its business around immediately. In fact, given the costs that the company will incur, the share price could languish at first. But in doing one or more of these things I think management will be sending a clear signal that the culture that has led to value destruction in the past is a thing of the past.
Disclosure: Ben Kramer-Miller has no position in Barrick Gold.