Earlier this year, Barrick (NYSE:GOLD) merged with Randgold to solidify its position as the largest gold producer in the world. Following this merger, Barrick owns one of the most geographically diversified portfolios of gold mines across the world, positioning the company to succeed in a variety of market conditions. Through the addition of these assets, as well as management's focus on streamlining operations to improve profitability, Barrick has positioned itself as an attractive opportunity for equity investors to add both a strong business and gold exposure to their portfolios.
Barrick's merger with Randgold gives the newly combined company control of five of the top ten Tier One gold mines in the world (though it doesn't own a 100% stake in all five mines). Tier One mines have potential reserves of 5 million ounces or more and can be mined with an internal rate of return greater than 15% based on the long term price of gold. In other words, Tier One mines are mines with tons of gold ore in them that can be extracted profitably. The merger is expected to give Barrick the lowest cost-per-ounce (extraction and refinement of ore) in the industry, based on estimates from Wood Mackensie.
Furthermore, Barrick's mines are located across the world in Africa, North America, and Latin America. This helps the company's profitability and cash flow as a whole stay resistant to natural disasters, accidents, or geopolitical turmoil that may affect its operations in one area. Regardless of issues in one part of the world, Barrick's geographically diversified portfolio should allow the company to maintain its business momentum.
Barrick profitably produces a tremendous amount of gold each year and is poised to continue doing so for many years. It had a gross income of $2.1 billion in 2018. With a $538 cost per ounce, according to company estimates, Barrick should be profitable even if gold prices fall significantly from their current levels around $1280/oz. If gold prices rise, of course, Barrick will see an increase in its profitability.
Past Mistakes and New Efficiency
Barrick made a number of mistakes over the past couple of years and a somewhat bearish market for gold in recent years didn't do the company any favors, but Barrick has refocused on improving its management structure and efficiency. The best example of Barrick's past mistakes comes in the form of its investment in the Pascua-Lama mine, located on the border between Argentina and Chile. Barrick invested $5 billion in preparing the mine for production with the expectation that mine would have a very low cost of operations. However, due to legal and environmental concerns, Barrick has yet to extract any gold from the mine. However, situations like this are part of the risks of the mining business. Mine development is risky and much of the cost occurs before any gold is produced and sold. Barrick is large enough to survive such problems, making its shares more attractive than smaller miners that could be bankrupted by a similar mishap.
The origin of much of Barrick's trouble was its aggressive acquisition program. The company took on a lot of debt to finance acquisitions that made it the biggest player in the gold industry. Its debt peaked in 2013 at $15 billion, just when gold prices began a decline that lasted until 2016. This combination of high debt levels and diminishing profits from its mining operations made the stock unattractive to shareholders. However, gold prices have recovered slightly from their 2016 lows, and, more importantly, Barrick has retired $10 billion in debt since 2013. Less than a $100 million of the remaining debt is due before 2020, and 85% of it is due after 2032. Furthermore, Barrick did not acquire Randgold by taking on debt but rather did it through a stock-for-stock exchange where Barrick traded its own shares for a controlling interest in Randgold. As a result, Barrick's balance sheet is healthier today than it has been in a number of years.
In the post-merger Barrick, the former Chief Executive of Randgold Mark Bristow has become the President and Chief Executive of Barrick. Mark Bristow has decentralized the management by establishing regional management offices for North America, Latin America and Australia Pacific, and Africa and the Middle East. This is a change from its previously centralized management structure and should allow Barrick to better manage its globalized portfolio.
Barrick has also been improving its portfolio by selling off assets that are not producing sufficient profits. This has allowed the company to increase its cash-flow and profitability by reducing the drag of higher-cost mines on its portfolio. It used the proceeds from these sales to retire the debt which had previously weighed down its balance sheet. The combination of an improved management structure and a stronger balance sheet makes the post-merger Barrick a very different and much stronger company than the one it was from 2013 and 2018.
Barrick appears to have made the right moves to reposition the balance sheet and stabilize the company for future growth. However, much of its performance will depend on the price of gold going forward. As mentioned above, Barrick's very low cost-per-ounce means that it can be profitable even if gold prices stay at current levels or decline a bit. However, if gold prices rise, its profitability will increase allowing the company to retire debt faster, acquire more mines, or even return more cash to shareholders. Since the price of gold is fundamental to Barrick's future performance we need understand why its price moves.
Gold prices price tend to experience dramatic bull runs followed by sharp drawbacks. Generally, during times of inflation and economic uncertainty gold prices rise, although the correlation is not perfect: Don't expect gold to jump on the same day the market crashes. However, gold performed very well during the economic turmoil of the late 70s and early 80s and again from 2006 to 2013. Investors like to buy gold during times of economic turmoil because gold tends to hold its value well, protecting investors from losing capital in the stock and bond markets and from losing the value of their cash through inflation. When inflation rises, gold holds its relative value, causing its nominal price to increase. Conversely, During times of prosperity and stability gold prices tend to pull back during periods of economic prosperity, as evidenced by gold's mediocre run from the mid '80s to the early 2000s. Because of this, gold is sometimes referred to as a hedge against serious economic problems. For Barrick investors, this means that the stock's gold exposure can provide a counterweight to a portfolio in times where the broader market is in disarray.
Since future economic problems are usually very hard to foresee, it makes sense to include exposure to gold as part of a well-balanced portfolio. However, gold bullion can be a drag on your portfolio as it was for many years during the 80s and 90s. Owning a well-managed and profitable gold mining company can provide a portfolio with the some of the same benefits as gold bullion should economic troubles arise while offering the chance to experience the gains that come from owning a solid business. The new post-merger Barrick has a strong balance sheet and a good management structure. Its focus on improving margins makes the company attractive to own with gold at current price levels. It will thrive if economic problems return and cause gold prices to take off once again but it can survive and stay profitable even if gold prices decline. Therefore, Barrick is worth considering for your portfolio.