Asset sales boost Barrick Gold

Barrick also announced a streaming agreement with Royal Gold for gold and silver from its 60% stake in Pueblo Viejo. Streaming agreements are not always ideal, as they limit the potential gains from rising prices, but we think the deal helps Barrick bring forward future cash flows to help reduce its hefty debt load. In addition, the deal structure still gives Barrick some upside to rising gold and silver prices through ongoing cash payments tied to prevailing spot prices.

The favourable price received for Zalvidar offsets the impact of a lower gold spot price since our last update. Therefore, we are maintaining our U.S. dollar-denominated fair value estimate of $18 per share. We have increased our Canadian dollar-denominated fair value estimate to $24 per share from $22 per share, reflecting a stronger U.S. dollar relative to the Canadian dollar since our last update.

We originally were skeptical that Barrick could reach its $3 billion debt-reduction goal without asset sales, which we worried would occur at distressed prices in a challenging market environment. However, with $250 million from cash on the balance sheet already used to retire debt earlier this year and $2.7 billion in asset sales announced thus far, Barrick remains well within reach of its target. Furthermore, the company is exploring sale processes for several noncore assets and projects in the United States. Assets in this favourable geopolitical jurisdiction have had a lot of interest of late, so we are optimistic that Barrick can fetch good prices for these assets and reach its debt-reduction goal.

Low-cost portfolio for largest producer

Barrick is the largest gold producer in the world, anchored by a portfolio of five large mines that constitute roughly 60% of production. Individually, these mines produce as much as some mid-tier miners' entire operations do. While the company's entire portfolio operates at all-in sustaining costs below the industry average, Barrick's five core mines produce at AISC even below the company average. As a result, Barrick should be able to generate free cash flow even at today's lower gold prices.

Despite its low-cost portfolio, Barrick's primary focus is on strengthening its balance sheet. The company deployed heavy amounts of capital at what turned out to be problematic projects, saddling it with a large amount of debt. From 2010 to 2014, debt roughly doubled to more than $13 billion, driven by the roughly $7 billion acquisition of Equinox Minerals in 2011 and the continually escalating capital costs at Pascua-Lama, whose last capital cost was estimated at roughly $10 billion. Furthermore, the Equinox assets and Pascua-Lama are unlikely to generate the cash flow originally anticipated.

Our long-term gold price forecast of $1,283 per ounce in 2018 is based on the marginal cost of production for gold miners on an all-in sustaining cost basis. This includes both the cash costs and sustaining capital expenditures necessary to sustain current production levels. Our long-term gold demand forecast assumes solidly increasing demand, driven by China and other emerging markets. China and India already constitute an overwhelming share of gold retail demand. Given gold's cultural importance in both countries, we expect rising household incomes will propel continued demand growth.

Overinvestment prevents moat

Barrick Gold's all-in sustaining costs are under $1,000 per ounce, placing the company on the lower end of the industry cost curve. While its proven and probable reserves imply a mine life estimate below the average of our coverage universe, the reserve level still implies more than 10 years of production at current levels.

All else equal, this is a recipe for a moat. However, 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.

The Pascua-Lama project is emblematic of Barrick's missteps. Pascua-Lama is a high-risk, high-reward project on the border between Chile and Argentina. 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 last 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. However, this makes it unlikely that the company will generate any cash flow on the $5 billion-plus it had already spent at the time of deferral.

Barrick also spent a significant amount of capital in its acquisition of Equinox Minerals in 2011. Acquired during peak copper prices, 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. In addition, after the acquisition, the Jabal Sayid project faced questions from Saudi Arabia's Deputy Ministry for Mineral Resources, forcing the company to temporarily place the development on care and maintenance. Furthermore, copper prices have significantly dropped since the acquisition.

After spending significant capital on underperforming assets, the company would need a return to higher gold and copper prices combined with a successful and carefully managed opening of Pascua-Lama and Jabil Sayid before we would consider assigning it a moat.

Leveraged to gold, but not as much as some

Like most gold producers, Barrick is highly leveraged to gold prices. However, we believe the company is slightly insulated to fluctuations in gold price compared with other gold miners. All-in sustaining costs are roughly $800-$900 per gold equivalent ounce, which is on the lower end of the industry cost curve. Even at today's lower gold prices, the company can generate positive free cash flow.

Although Barrick has placed development projects at Pascua-Lama and Jabal Sayid on hold, we think it would face meaningful project execution risk if 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.

With much of its exposure in stable, mining-friendly jurisdictions, we think Barrick's overall portfolio only carries a moderate amount of geopolitical risk. Of Barrick's five core mines, the two largest mines, Goldstrike and Cortez, are in the U.S., while the remaining mines are in Argentina, the Dominican Republic and Peru. The company has additional exposure to North America through a number of smaller mines. Its remaining exposure is in the Australia Pacific region and Africa.