Barrick Gold's Attempt to become Leaner Comes at the Right Time

Nihar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I like Barrick Gold's (NYSE: ABX) focus on maximizing the utility of cash, while looking for places to cut costs. That may seem like an obvious choice, but when the company is extracting gold for less than $600 per ounce and the price of gold is around $1700 per ounce and climbing, that focus is laudable. It would be so easy for Barrick to decide to scale production and claw as much gold from the earth as it can. When the price of gold is accelerating the company's profits, it is all too easy to ignore costs.

Barrick is trying to appease people concerned with its upwardly revised cost per ounce guidance, but there is a long way to go before Barrick is losing money per ounce. Controlling spend is one of the focus points in the Q3 conference call, but the more important focus is what they called its "capital allocation strategy." It is a fancy way of saying that it wants every item in its portfolio to be the most efficient use of the company's capital.

The plan as I understand it does not seem to be cutting losing or barely profitable ventures. Even ventures with a solid profit that would end up being a drag on the company later are being cut. It is a portfolio-oriented approach, meaning that if there is a project with a steady return that brings down the average of the whole portfolio it would either have to bump up the return or be divested. That way the return average of the whole portfolio goes up.

That is part of its new goal to maximize shareholder value and increase the free cash flow. The goal is to return more money to shareholders, which is not a bad thing. One of my main problems with holding gold is that I think it is a fickle commodity that has had a long stretch of good times, but in the past it has collapsed and it might do so again at any time. If you love the metal itself then you might go with SPDR Gold Shares (NYSEMKT: GLD), but I prefer the business of the metal. GLD is a pure play on the price of gold bullion increasing. Barrick is an investment on gold mining.

GLD reflects the complete value of the price of gold, and declining prices mean a loss in value. Gold mining companies can continue to generate a profit even if gold declines, but they will have less profit. For the ETF gold needs to continue increasing in value, and any decline means a loss in your portfolio. That is why I like Barrick's focus on returning value to shareholders. Once that value is given to shareholders it is divorced from the metal, because it is money in the bank.

Barrick also reaffirmed its commitment to a progressive dividend, but for now they maintained the dividend at the same level. After reading the conference call I am confident in management's ability to create a solid company going into the future. It was just shocking to see such a mellow approach to the gold industry, because most of what I read about gold is either that it's going to hit $5,000 per ounce or the bubble is about the burst. Obviously, conference calls are going to show a greater stability in language, but Barrick has a controlled approach to business that I like. On top of that, the profit margin is 22.88%, and it is still looking for extra savings. Although last year it was in the 30%-range, so it is not surprising that the company is taking steps to improve this.

If you really want a high margin then you can go with Goldcorp (NYSE: GG), which has a 32% margin for the latest quarter. The earnings call for Goldcorp was in line with what I was expecting. There was a lot of talk about existing and new projects. Details like production, problems, logistics, and new projects were discussed. All of these are important and I am not being critical, but the only conclusion I can draw is that Goldcorp's grand strategy is dig, and dig more. That is fine, but I would be concerned if gold started to decline, and Goldcorp had less than fantastic projects. Not to say that it would go under, but it would eat at the value of the company. The same would happen to Barrick, but management there made it a point to discuss returning value to shareholders.

The lack of a business strategy does not mean that Goldcorp's management does not know what it is doing, because it has an operational strategy. It just means that the focus is on assets in the ground. Barrick is moving away from that model and focusing on the structure of the overall business, with assets in the ground being important, but not the sole consideration.

Goldcorp has significant production, has a nice margin, and has $1.65 billion in net income ttm, which is less than Barrick's $4.1 billion; but it is a smaller company. It also has a very low debt load, with the debt to equity ratio at 0.0342. Barrick's is higher, but not alarmingly so, at 0.5129. The point is that both companies have their merits, but each is just for the different kind of investor.

Conclusion

As a potential investor I like Barrick's proposal, but if I was a serious goldbug I would like Goldcorp's approach. Both companies have their merits, but I am not a firm believer in the power of gold. I like Barrick's approach much better. Both of these companies are miners, so you can look forward to future revenues as gold appreciates. GLD is a staple for gold lovers, but since gold is already up to $1700 per ounce any pullback would lead to a loss in value if you were to buy now. If you are just entering gold, consider miners instead.

Barrick's earnings report was not well received, so wait for the dust to settle before jumping in. If luck is on your side, the reaction will be overdone.


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