When a deep commodity downturn started in 2011, Barrick Gold Corporation (NYSE:ABX) and most of its peers were still living in the glow of the upturn. As gold prices started falling, however, it became clear that Barrick couldn't support all its expansion plans and the weight of its hefty debt load. Since then, it has easily done more than its peers to fix its debt overhang. But investors need to be aware of more than just debt reduction when looking at Barrick.
History repeats itself
Commodity prices tend to be highly cyclical. The pattern is so similar each time that you'd think miners would be able to resist the temptation to overextend themselves. But the so-called animal spirits of the market are a siren call that few can avoid succumbing to. Which is why so many miners, Barrick included, were caught off balance in 2011 when commodity prices started a steep decline.
At the time, Barrick had big, expensive growth plans in place that it was funding with debt. To put a number on that, the miner's long-term debt roughly tripled between 2009 and 2011. The absolute value topped out at nearly $13.2 billion, representing around 36% of the company's capital structure at the time.
But the downturn took a big toll, with losses and asset write-offs over the following years reducing shareholder equity. By the end of 2014, long-term debt had fallen a miserly 3%, but shareholder equity had declined 56%, leaving the company's long-term debt at a troubling 55% of the capital structure.
Putting a new trend in place
That is where this story really begins. Barrick was well aware of its leverage issue and set out to repair its balance sheet. In 2015 alone, it cut its debt load by 23%. It followed that up by trimming long-term debt by another 20% in 2016. And in 2017, long-term debt fell another 18%. Asset sales, cost cutting, and streaming deals, among other things, all played a role in this effort. As of the first quarter of 2018, Barrick had trimmed its long-term debt by a massive 51% since the start of 2015.
Barrick isn't the only major miner that's been focused on debt reduction. But it has been beating peers like Newmont Mining (NYSE:NEM), Kinross Gold (NYSE:KGC), and Goldcorp (NYSE:GG) on this front, in some cases by a very wide margin. Barrick estimates that the massive balance-sheet effort has saved it around $300 million a year in interest expenses. Long-term debt is now back down to around 30% of the miner's capital structure.
Things are better, but...
During the heat of the downturn, investors were rightly concerned that heavily indebted miners like Barrick needed to adjust, or they would end up in deep trouble. Barrick's debt reduction efforts and the 2016 upturn in commodity prices have calmed those fears. However, you shouldn't stop thinking about Barrick's balance sheet just yet.
The miner professes that it wants to be more prudent in the future than it had been in the past. Which is exactly what you want to hear as an investor. However, past actions speak louder than words. If you own Barrick, you'll want to keep watching to make sure management continues to live up to its fiscally prudent words.
That's particularly important when you step back and compare the miner's leverage to peers. Yes, Barrick has been more aggressive in its efforts to trim debt. But even after the massive reduction, it still has a more-leveraged balance sheet than many of its closest competitors. For example, as the chart below shows, financial debt to equity is at the high end compared to some of the world's largest gold miners.
And while Barrick is on sounder footing than Goldcorp with regard to financial debt to EBITDA and the current ratio, it isn't exactly leading the pack when it comes to having a conservative financial structure.
That's not to suggest that the miner is at any risk of financial distress today. Far from it, after its successful effort to trim long-term debt (and the rebound in commodity prices). But Barrick's more-aggressive debt reduction was needed. And it shouldn't lead investors to overlook the fact that it is still more highly levered than its peers, which is something of a statement about management's more aggressive business approach.
There will be another cycle
Barrick Gold has done a great job of executing its plans to improve its balance sheet strength. But as I said, it remains more financially leveraged than some of its closest peers. Since the cyclical nature of the mining business that led to Barrick's current debt trimming is going to repeat itself at some point in the future, investors should keep a close eye on the company's financial foundation. Animal spirits are hard to resist, no matter what promises management makes about remaining fiscally prudent the next time around.