After Berkshire Hathaway picked up a roughly $565 million stake in Barrick Gold, the world's second-largest gold miner, interest in the stock has increased.
While many believe that Buffett has changed his stance on gold, it is worth noting that he did not purchase gold but picked up a gold mining company that pays dividends.
In Why investing in gold mining stocks is not easy, I mentioned the multiple factors that tend to play havoc with the stock price; much more than what regular businesses face. Macro-economic factors. Commodity prices. Labour unrest and strikes. Wrath of human right activists and environmentalists. Country-specific issues (Interference from the government, tax, geo-political). Also, once discovered, it takes a few years for the company to start producing that metal. So actual production right from discovery, can be a very long wait.
Let’s look at this through the perspective of Barrick Gold.
I have drawn on Morningstar’s research of the stock by Kristoffer Inton, director of equity research – basic materials.
Last year, Argentina upheld its Glacier Protection Law, rejecting the challenge by Barrick Gold. The law bans mining in glacial and permafrost areas. Barrick owns the Veladero gold mine in Argentina and the Pascua-Lama project on the Argentine-Chile border.
Pascua-Lama is a high-risk, high-reward play. It was originally expected to cost roughly $3 billion, but saw capital costs continually escalate during its construction to roughly $10 billion at the company's most recent estimate. With expected production of about 825,000 ounces at extremely low production costs, the mine would meaningfully increase production below the company's average costs.
In 2013, Barrick placed Pascua-Lama on care and maintenance, deferring further construction while maintaining the option to resume development. While the company is exploring options at the mine, we still think it is unlikely that the company will generate positive returns on the $5 billion-plus it had already spent at the time of deferral in addition to the incremental capital needed in an updated mine plan.
In 2011, Barrick acquired Equinox Minerals. At a time when copper prices had peaked, Barrick spent roughly $7 billion on the acquisition, which included the Lumwana mine and Jabal Sayid development.
Barrick was forced to re-evaluate operations at Lumwana after the acquisition, as prior owners boosted short-term production at the expense of long-term viability.
Post acquisition, the Jabal Sayid project faced questions from Saudi Arabia's deputy minister for mineral resources, forcing the company to temporarily place the development on care and maintenance. Furthermore, copper prices have significantly dropped since the acquisition
Although Barrick has placed development projects at Pascua-Lama and Jabal Sayid on hold, we think the company would face meaningful project execution risk if and when it brings these projects back on line. In particular, we believe Pascua-Lama entails a significant amount of risk, given the cross-border position of the ore and operations, the high altitude in the Andes, and the delays and capital cost inflation already experienced since the project first entered the pipeline.
- Barrick Gold holds a large portfolio of mines, with more than 10 mines individually producing 200,000 ounces or more.
- Like most gold producers, Barrick is highly leveraged to gold prices. All-in sustaining costs are roughly $850-$950 per gold equivalent ounce. Although not on the lower end of the cost curve, the company should be able to generate positive free cash flow even under lower gold prices.
- We assign Barrick Gold a Standard stewardship rating. The company has a mixed record when it comes to the stewardship of shareholder capital. On the positive side, Barrick has put together a large, diversified portfolio of mines and has adopted a much more disciplined approach to acquisitions. On the negative side, Barrick has spent a lot of capital on assets that are unlikely to open or generate the level of cash flow originally expected.
- In recent years, Barrick has been focused on strengthening its balance sheet. From 2010 to 2014, debt roughly doubled to more than $13 billion. In 2015 and 2016, Barrick executed noncore asset sales, royalty streams, and other transactions to help drive leverage down to a more manageable level, raising more than $5 billion for debt reduction. The company reduced debt by an additional $1.5 billion in 2017.
- Barrick's costs are not low enough to justify a moat. Barrick Gold's all-in sustaining costs are roughly $850-$950 per ounce, higher than its cost profile in recent years. The company no longer operates on the lower end of the cost curve. Its proven and probable reserves imply a mine life estimate of more than 10 years of production at current levels. In addition, the company spent enormous sums on assets during peak prices, some of which are unlikely to ever open. Its massive and overpriced invested capital base makes it unlikely that the firm will generate economic returns in excess of its cost of capital, even if it can get costs lower.
