Miners Tighten Purse Strings
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Barrick Gold (NYSE: ABX) is putting holds on the development of two mines, one in Alaska and one in Chile, as the uncertainty of global economic conditions remains.
And it is not the only company doing this. Kinross Gold Corp. (NYSE: KGC) is doing the same things to mines in Ecuador and Chile, as it expands its Tasiast project in Mauritania. Gold mining costs continue to rise. Wages are soaring with the shortage of skilled labor while the cost of raw materials also goes up.
When one adds to that two unplanned setbacks (that regularly occur) with lower grade ore from older operations, this has a huge affect upon gold mining companies’ bottom lines. To give just one example, Barrick said Tuesday 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.
For Barrick, the whole turn around might have started with the Pascua-Lama boondoggle in Chile. This mine is located 12,000-17,000 feet in the Andes on the border of Chile and Argentina. When the budget was set in 2009 its projected development was $3 billion. Estimates were later expanded to $4 billion and then $5.7 billion. Costs for development will be 60% higher and now production has been pushed back from 2013 to 2014. What is the reason for this gross misjudgment? Among the explanations given by the company are the project’s unanticipated complexity, delays to a tunnel and processing plant, and local cost inflation.
One Consequence of Pascua-Lama
Ratings agency Standard & Poor’s lowered gold producer Barrick Gold’s corporate credit rating to BBB-, from it previous A+ standing. It was the Pascua-Lama capital expenditure increases that caused this. One cannot continue to poor billions into a project that is not generating revenue and continue to push the revenue projections out into the future. S&P's said:
“We believe that the latest revisions to Pascua-Lama likely preclude any meaningful balance-sheet deleveraging in the next 12 months.”
Execution risks surrounding Pascua-Lama may challenge the credit measures and cash flow of the company even more. Barrick reported its second-quarter profit fell 35%, while its adjusted net earnings sank 30%. Enough is enough. As stock prices fall investors are demanding change to this once profitable industry. This is a company that continues to struggle.
Mining companies had had the fortune of growing through the years through acquisition or high-risk ventures while the increasing price of gold kept them afloat, and investors did not complain. But now that things are different in the world of gold, these same companies are having to take a good hard look at how business is being carried out. Companies are having to reexamine projects they are working on to see if they are profitable. Gone is the mentality to "produce first" all the gold you can at whatever the price and let the ever increasing value of gold carry you through it! As budgets tighten, gold miners will now have to look at projects based upon the cost to extract it from the earth. They are now going to have to look at the return on their investment.
Chuck Jeannes, CEO of Goldcorp Inc. (NYSE: GG) said in a recent interview:
“From the new projects side, we’ve been pretty deliberate in trying to acquire and then build projects that have very strong returns.”
Investors are now demanding a better return on their investment in these companies now that the economic landscape has changed for gold. Investors are looking for a good rate of return with healthy cash flows. In today's market, dividends are important ans these companies are not keeping up with other industries when it comes to a good rate of return.
Yes, things are changing for the mining companies. While they deal with normal change in the industry they now will have to become more responsible to investors who increasingly are demanding more for their investment. Don't look for more high-risk ventures from these companies; they will be prioritizing work and focusing on areas that bring them the best return for their dollar. Times are changing and gold miners are tightening purse strings.
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