Cheap Gold Exposure with a Best-in-Breed Miner

(This is a highly-abbreviated version of a full SumZero report republished with the author's consent)

Contributor: Brett Janis, CFA.
Firm: Prism Asset Management. Hedge Fund.
Location: New York, NY

Recommendation: Long Shares of Barrick Gold (NYSE: ABX)
Timeframe: 1 to 2 Years
Recent Price: $38.50
Target Price: $60.00

Strategy: Growth at Reasonable Price (GARP)

Quick Thesis:
Gold mining stocks have traded down in recent months on short-term retrenchment of gold prices to mid-$1500 as well as fears that rising mine production costs will squeeze margins. Barrick Gold (NYSE: ABX), currently trading close to $40, has underperformed the price of gold, remaining one of the cheapest gold miners on a relative basis with a P/E of 8.5x.

While sell-side analysts favor ABX, applying high 12-month price targets, investors have voted with their sell orders, pushing down the price more than 20% YTD. Gold miners are unloved, despite Gold's historically high prices. The channels for investing in gold have increase dramatically in recent years, primarily because of Gold ETFs, and this wider array of products has reduced investor demand for gold miners. Barrick, along with other gold miners, remain captive to equity allocations.

The low carry cost as evidenced by near 0% real interest rates in the developed world (the US is a negative real interest on the short end of the curve) fundamentally supports gold as a store of value. ABX's proven reserves are 138 million ounces, a strong base of extraction so that achieving growth is not dependent on exploration factors, but rather challenges related to extracting from existing mines. The resource base greatly reduces risks for the business, justifying a much higher P/E than current 8.5x. Rather, ABX should naturally trade at a multiple of 12.0x, still less than 75% of its peers. Multiple expansion and net profit growth should provide the necessary catalysts to contribute to the higher target price.

Over time, costs of extraction should be contained with new technologies. ABX's current average extraction costs are $500 per ounce and fears related to rising costs are mitigated by the firm's ability to leverage its size.

Bottom Line:
As a multinational business, ABX represents a tremendously strong long thesis with high visibility into mineral extraction. As precious metal’s prices stay high and go higher, equity investors will likely pay closer attention to where the metals actually come from and the companies that mine them.

Leading mining companies should increasingly be perceived as industrial companies, meaning businesses that are capable of producing a desired product that also offers reliable earnings, free cash flow and strong dividend yields. When viewed on this basis, ABX’s thesis stands out for is ability to achieve low cost production and access to financing necessary for the capital intensive business.

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