Barrick Gold's weak earnings raise concerns
Failure to bring production from low-cost mines into the production mix will put pressure on margins in the short term.
Barrick Gold announced a 50% to 60% increase in capital costs for its Pascua-Lama gold mine from the top end of the previously announced estimate of $4.7 to $5 billion, with first production expected in mid-2014 instead of mid-2013 as estimated earlier. This delay and cost escalation comes as a huge setback to the company, which claims that Pascua-Lama will be one of the world's cheapest gold mines once production begins.
Estimated to have a long life of 25 years, Pascua-Lama is crucial to Barrick Gold's future. The company has attributed increased costs to a combination of high inflation in Argentina and Chile, lower-than-expected contractor productivity, schedule extension and engineering and planning gaps. Project execution has been tardy due to the challenging physical environment at high altitudes and the company's decision to use in-house capabilities rather than outsourcing the work to external partners. Management is being put under the microscope for not having detected such serious problems earlier.
We expect total cash costs to be lower in the second half of the year if the company sticks to its promise of significantly higher overall production levels and lower cost mines contributing to a greater share of total company production. Failure to bring production from low-cost gold mines into the production mix will put pressure on margins in the short term. This could, however, be offset if gold prices rise which, in turn, would be determined by the general macroeconomic environment.
Rising costs are also a problem at its Lumwana copper mine. Barrick has blamed the previous owner Equinox for the same, alleging that the practices followed by them were less than satisfactory. Barrick is attempting to rectify those mistakes, resulting in cost escalations. On the other hand we believe that economic slowdown, particularly in China, has reduced demand and resulted in a fall in prices. Due to an extended strong price rally prior to the recent fall, we think that in the worst case a supply glut will hit the market on the back of increased output. This will lead to further correction in copper prices, impacting Barrick's margins in the copper business.
The $400 million Jabal Sayid copper project in Saudi Arabia, with an estimated 1.2 billion pounds of copper, will start production in the second half of 2012. The mine will add approximately 130 million pounds of copper annually. Thankfully, the total cash costs are expected to be much lower at $1.50-$1.70 per pound as compared to the average cost of $2.28 per pound this quarter.
Despite setbacks, Barrick Gold does possess very strong long-term productive assets and once Pascua-Lama and Pueblo Viejo come online, we expect it to perform well. And despite rising costs, Barrick's cost profile is much better than the industry average. In the short term, Barrick remains dependent on Goldstrike, Cortez Hills, and Veladero mines to generate attractive returns at prevailing prices. Rising energy costs will continue to put pressure on margins in the short-term.
We are currently in the process of updating our estimates for Barrick Gold in light of recent earnings.
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