Barrick: An Out-of-Favor Value In Gold

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Many investors would look at a list of new buys in a contrarian’s portfolio and wonder just what, exactly, the contrarian was thinking.

“Why don’t you just buy these stocks that are working” is a common thought which is also frequently shared in such examinations.

Contrarian investors need to patiently wait, sometimes painfully, while other stocks surge higher. But, if done right, and maybe with a little help from the impossible-to-time but inevitable market cycles, a contrarian’s stocks produce not only strong gains but also do so at a time when more popular stocks suffer.

We recently added a new name, Barrick Gold (GOLD) as a "Buy." This stock is not only out of favor (a classic contrarian trait), but is not infrequently looked upon with doubt, disdain and discredit.

The entire gold mining industry isn’t immune to such views, either. But the gold mining industry, and certainly Barrick, has lost the loose-spending and often murky culture of decades ago.

Today’s gold mining industry is one of restraint, transparency and financial discipline — hard-earned from the long struggle with chronic low commodity prices and disappointed investors. Barrick’s chairman is a former Goldman Sachs president, hardly someone who would wantonly waste shareholder money.

Impressively, in his first year at Barrick, Bristow created a joint venture that combined Barrick’s and Newmont Mining’s Nevada gold mines into a single world-class operation, generating large cost and productivity improvements.

Since their mid-2020 peak at around $2,000/ounce, gold prices have slipped about 15% to $1,730/ounce. Barrick’s shares have slid over 30% - not completely surprising as mining company stocks magnify the moves in the underlying commodity. With the fall-off in the share price, Barrick shares now have considerable appeal.

Our thesis is based on two points. First, that Barrick will continue to generate strong free cash flow at current gold prices, continue to improve its operating performance and return much of that free cash flow to investors while making minor but sensible acquisitions.

Demonstrating its commitment, the company will pay $0.42/share in special distributions this year, in addition to its regular $0.09/share quarterly dividend. Barrick’s balance remains solid, with its $5.2 billion in debt fully offset by its cash balance.

Second, that Barrick shares offer optionality – if the enormous fiscal stimulus, rising taxes and heavy central bank bond-buying produces stagflation and low interest rates, then the price of gold will move upward and lift Barrick’s shares with it. Given their attractive valuation, the shares don’t need this second (optionality) point to work – it offers extra upside.

Major risks include the possibility of a decline in gold prices, production problems at its mines, making a major acquisition and/or an expropriation of one or more of its mines.

At about $20, Barrick shares trade at a sizeable discount to our value estimate of $27, based on 7.5x estimated 2021 EBITDA and on a modest premium to its $25/share net asset value.

The combined dividends this year will produce a 3.7% yield. Although the company may not pay a special dividend next year, it could raise its recurring dividend to provide an above-market yield. We think Barrick has a much better future than the market is assuming.

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William K. 2 years ago Member's comment

With the threat of inflation foremost in some folks minds it is not likely that a drop in gold prices will last long enough to be a concern item.