Bloomberg News

Barrick Gold Chases Returns Instead of Ounces

July 27, 2012

After years of takeovers and mine expansions buoyed by soaring gold prices, Barrick Gold Corp. (ABX)’s former chief financial officer is bringing the company back down to earth.

Barrick, the world’s biggest gold producer, said yesterday it began a review of all its assets. Chief Executive Officer Jamie Sokalsky, who’s been in the job seven weeks, said some development projects don’t meet new requirements and output targets will be lower. Production growth will be driven by rates of return, “not the other way around,” he said.

Sokalsky, 55, is bowing to pressure from investors to be stricter on capital allocation and cash flow after the cost of Barrick’s Pascua-Lama mine blew out by as much as 60 percent to $8 billion. After 11 straight years of gains which have seen gold rise more than fivefold, the price of the precious metal is up just 3.9 percent this year, giving producers less room for maneuver and pushing them to focus on returns instead of output. Barrick said July 6 it fired Sokalsky’s predecessor Aaron Regent after being disappointed by its share price performance.

“I think it’s the company adopting what shareholders were looking for,” said David Christensen, CEO of ASA Ltd. in San Mateo, California, which manages $600 million and invests in precious metals companies. “He was preaching to the choir.”

Barrick dropped 4.2 percent to C$33.04 in Toronto yesterday after reporting the higher cost of Pascua-Lama and posting second-quarter profit that was lower than expected. The shares have declined 29 percent this year. The shares declined 1.7 percent today to close at C$32.49.

Dissatisfied Investors

The NYSE Arca Gold BUGS (HUI) Index of 16 gold-mining companies has fallen 17 percent in 2012. The index is trading at about 13 times earnings, compared with a five-year average multiple of 35, according to data compiled by Bloomberg.

Gold-mining valuations show that investors have been “dissatisfied” with capital allocations in the gold industry, Sokalsky said yesterday in a conference call.

“They are looking for higher rates of return and free cash flow, not just production growth for the sake of production growth,” he said.

Mining investors are becoming more interested in short-term results and returns, said Caesar Bryan, portfolio manager at Gabelli & Co. Inc. in Rye, New York, who owns Barrick stock. Bryan says he doesn’t agree with that shift.

“Gold investors in the olden days looked more at reserve growth, growth in reserves and production growth over the long haul,” Bryan said. “Now it’s about what are the earnings this quarter, last quarter, next quarter.”

Cost Revisions

Sokalsky is a chartered accountant who spent a decade at Canadian food processor and distributor George Weston Ltd. (WN) before joining Barrick as treasurer in 1993. He became CFO in 1999. He’s the third CEO at Barrick in less than four years.

Returns will be a “core element” of Barrick’s investment decisions going forward and will be measured based on free cash flow and risk-adjusted returns, he said on the call.

Pascua-Lama, located 3,800 to 5,200 meters (12,468 to 17,061 feet) up in the Andes on the border between Chile and Argentina, was forecast to cost no more than $3 billion when Barrick, then led by Regent, approved its go-ahead in 2009.

That estimate was revised to $4.7 billion to $5 billion in July last year. Barrick said yesterday the price tag will be about 50 percent to 60 percent more than the top end of that range. Initial production will now be in mid-2014, not mid-2013. Among the explanations given by the company are the project’s unanticipated complexity, delays to a tunnel and processing plant, and local cost inflation.

‘Very Disappointing’

“Ultimately the project management structure was inefficient and created productivity issues so we didn’t get things done as well and as quickly as we could have,” Sokalsky said yesterday in a telephone interview. “The delay in the schedule did surprise me and it’s very disappointing.”

While Barrick still plans to proceed with Pascua-Lama, it said yesterday that the Donlin Gold project in Alaska and the Cerro Casale project in Chile don’t currently meet its investment criteria.

Some of Barrick’s competitors have had to make similarly tough decisions this year. Canada’s Kinross Gold Corp. (K) said in February it would delay development of mines in Ecuador and Chile and concentrate on the expansion of its Tasiast project in Mauritania, where labor and raw-material costs have climbed. Kinross CEO Tye Burt said May 9 that his company is using stricter criteria for spending.

Gold-mining costs are rising as wages soar because of a shortage of skilled workers. Operational setbacks and companies producing lower-grade ore from aging mines are also contributing to inflation. Barrick said yesterday that its so-called total cash production cost was $613 per ounce of gold in the second quarter, 38 percent higher than a year earlier.

Barrick M&A

“I’ve been telling our mine managers for the last three years to focus on cash flow, not ounces,” Chuck Jeannes, the CEO of Goldcorp Inc. (G), Barrick’s biggest Canadian competitor, said yesterday in an interview. “From the new projects side, we’ve been pretty deliberate in trying to acquire and then build projects that have very strong returns.”

Barrick, founded by Chairman Peter Munk, has paid about $19.4 billion over the past 10 years to acquire other mining companies, according to data compiled by Bloomberg. It paid about $10.2 billion in 2006 for rival Canadian gold producer Placer Dome Inc., a record sum for a gold takeover.

In July last year, Barrick bought Equinox Minerals Ltd C$7.46 billion ($7.43 billion), giving it control of the Lumwana copper mine in Zambia. Barrick said yesterday that Lumwana’s production this year will be less than expected as the company changes the way the mine is operated.

Sokalsky didn’t rule out future acquisitions.

“We’ll look at everything under the auspices of this disciplined capital allocation program,” he said in the interview. “Every dollar of capital is going to compete in the company and I couldn’t say that we are going to try to move in one direction versus another in terms of buy versus build.”

To contact the reporter on this story: Liezel Hill in Toronto at lhill30@bloomberg.net

To contact the editor responsible for this story: Simon Casey at scasey4@bloomberg.net


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