As Barrick tones up, investors fail to notice

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How can the world's largest producer of the world's hottest commodity finish dead last in a yearly profit ranking of Canada's largest corporations? And how can its share price fail to soar after it then frees itself of a hugely burdensome hedging program and posts record profits?

When Toronto's Barrick Gold Corp. released its second-quarter operating results at the end of July, management had lots to crow about. Adjusted profit climbed 76 per cent to a record $759-million (U.S.) or 77 cents a share, and operating cash flow exceeded $1-billion for the second quarter in a row.

It was a dramatic turnaround from last fall, when Barrick bit the bullet and took a massive $5.7-billion charge to eliminate its gold price hedging program, which had required it to fulfill fixed-price delivery contracts signed years earlier, when bullion was trading far below $1,000 an ounce. Barrick posted a $4.3-billion loss for 2009, dragging it down to the bottom of the annual Top 1000 ranking by The Globe and Mail's Report On Business magazine.

Now, the hedges are gone. "We have full 100 per cent upside to the gold price," Barrick chief financial officer Jamie Sokalsky said in an interview.

The trouble is that Barrick's share price, like those of other major producers, is still lagging the price of bullion. When the company announced last Sept. 8 that it was eliminating its hedges, its shares were trading near $42 (Canadian) on the Toronto Stock Exchange. On Monday, Barrick closed at $45.59, only about 5 per cent higher. Meanwhile, bullion has climbed by almost 20 per cent, to about $1,200 (U.S.) an ounce.

According to classic investment theory, of course, gold producers' shares should increase proportionately more than bullion prices because of inherent leverage - any given jump in the price of gold translates into a much larger boost to a producer's bottom line, all other factors being equal.

So why are markets cool to gold stocks, but still bullish on the metal itself? For some of the same reasons: As a recent UBS gold report notes, "many of the initial issues supporting gold are not yet solved. High fiscal deficits are still in place, with the recent problems in Europe still able to spill over to other parts of the world. This leaves concerns about monetizing the debt on the back of inflation."

Yet that global economic uncertainty has also driven investors away from stocks in general lately, including gold producers, and into perceived safer havens such as U.S. Treasuries.

In Barrick's case, the company might also have got all the short-term pop that was possible in its share price last fall. The price of bullion was soaring, long-time Barrick investors had been pressuring management for years to close the hedge book and the stock market was buoyant. "We felt we could issue a substantial number of shares and take out this position in one fell swoop," said Mr. Sokalsky.

In addition to closing the hedge book, Barrick also closed the biggest bought deal in Canadian history in last September: $4-billion. "They lapped it up," Mr. Sokalsky said. "The timing was really ideal for us."

Despite dilution from the issue, Barrick's share price on the TSX climbed from just below $40 (Canadian) in late August to a peak of over $50 last December, the day after it announced it had eliminated all its hedges. It did that by buying 3.5 million ounces of gold in the open market at about $1,000 (U.S.) an ounce to fulfill the old delivery contracts.

Since then, however, it's been a question of just how much more the company has to do to impress investors. Its shares have been trading at about 13 times forward earnings lately, about half the multiple they were a year ago, and substantially less than Canadian-based rivals Goldcorp Inc. and Kinross Gold Corp.

Barrick's management and many analysts think investors ought to look more closely at its impressive operating fundamentals and prospects.

With the hedges off, the company expects its average cash margin on gold for all of 2010 will be about $755 an ounce, almost three times what it was three years ago.

Barrick hopes to boost those margins over the next several years with three massive new lower-cost mines. Cortez Hills in Nevada, which just came on-stream in the first quarter of this year, produced at a cash cost of just $300 an ounce in the second quarter.

The two other mines are ramping up: Pueblo Viejo in the Dominican Republic should be in full production by the fourth quarter of 2011. Pascua-Lama on the border between Chile and Argentina should be producing by 2013. Estimated cash costs there will be just $20 to $50 an ounce, making it "one of the world's lowest-cost gold mines," Haywood Securities Inc. analyst Kerry Smith wrote in a recent report.

Like rivals Newmont Mining Corp. and Yamana Gold Inc., Barrick also boosted its dividend after releasing its latest quarterly results - by 20 per cent to 12 cents per quarter. But the 1.1 per cent dividend yield is hardly a huge sweetener.

After all the dramatic initiatives over the past year, even Mr. Sokalsky isn't counting on any huge share price jump any time soon. "The market takes time to see it," he says. "We're confident we're going to get an ongoing boost from this as we move forward."

All companies had Dec. 2009 year-end. All report in U.S. dollars.