Why You Should Buy Barrick Over Goldcorp, Peers
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Despite poor economic progress and the Fed's reiteration of low interest rates, gold producers have fallen over both near and intermediate-periods. Over the last six months, Newmont Mining (NYSE: NEM) has lost 22.1% of its value versus 25.3% and 26.7% for Barrick (NYSE: ABX) and Goldcorp (NYSE: GG). While several contributors on Seeking Alpha have speculated about a double dip, Fed Chairman Ben Bernanke, in his recent testimony, explained that he does not expect such an adverse event. If the economy starts improving (as it has, albeit slowly) and large gold producers have failed to outperform in the current macro climate, investors naturally want to know where and why they should become basic material shareholders.
In my view, investors need to broadly diversify across the sector, among others, and buy disproportionately large stakes in leading picks. Banking on one individual stock is risky, so investors need to be mindful of the broader industry fundamentals and its secular trend. And while many investors may leave gold once its appeal as a "hedge" dissipates, there are some producers that are undervalued from a volumes perspective. Put differently, I recommend investing based on operations and less on the price of the precious metal.
I am particularly optimistic about Barrick's potential against Newmont and Goldcorp. The firm trades at a respective 7.5x and 6.1x past and forward earnings with a dividend yield of 2.4%. By contrast, Newmont and Goldcorp trade at a respective 8.8x and 11.3x forward earnings. Newmont offers the highest dividend yield at 3.2%; but it will become less meaningful if the qualified dividend tax rate is overturned, resulting in dividend tax rates as high as 40%. The discount to competitors on a multiples basis is unreasonable given Barrick's moat as the largest miner and bargaining power. When miners are searching for resources, they often need to orchestrate takeover activity - those with the greatest bargaining power stand the most to gain in terms of value creation (more on this later).
Much of the firm's potential comes from the Pueblo Viejo mine located on the central part of the Dominican Republic. The gold producer owns 60% of the project while Goldcorp owns the other 40%. Although some argue that political corruption will act as a headwind, I actually anticipate it being a tailwind in favor of corporate interests. The Dominican Republic is trying to create more jobs for it citizens, and the nation is aware that it can't act hostile towards operating businesses in conjunction with its economic goal. Gold processing will begin in 2H12 and anticipated to generate 1M oz of gold over the next 18 months. Barrick's committed contribution to construction was $2.3B for this project. Starting in 2012 with a ramp up to full production in 2013, Pueblo Viejo has been guided to contribute an annual average of ~625-675K oz of gold at total cash costs of $300-$350 per oz for the first full 5 years.
In terms of takeover activity, the company has been reportedly in talks about buying out Kinross Gold (NYSE: KGC). With proven and probable reserves of 62.5M ounces at a valuation of 0.7x book value, Kinross provides accretive value. Barrick, again, has attractive bargaining power to strike a favorable deal.
While Goldcorp is a 40% investor in the Pueblo Viejo, management recently lowered production guidance for 2012. Since I advise not betting on the price of gold, this makes me concerned about operational stability. With that said, the stock has fallen 12.8% in value since the announcement - an "overblown" reaction to the negative announcement. Investors who are interested in making a short-term trade are encouraged to buy Goldcorp off of the market correction and back more stable producers, like Barrick, in the long-term.
Second quarter production was decent with production sequentially rising from 530K oz in the 1Q to 578.6K in 2Q. One area that was disappointing - and continues to be disappointing - is Red Lake. Seismic activity has been detected, so the company is slowing the pace of rock de-stressing for development. Grade variability has been worse than expected and production guidance has fallen by 20-30%.
Yet another area that has been disappointing is Penasquito. Inadequate water supply has cut off throughput. While weather is always uncontrollable and permits are available for additional wells, time delays impact capital markets. Guidance in the region has fallen by 8-13%.
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