Barrick unveils setbacks, cost hikes, output revisions

Barrick Gold packed its much anticipated second quarter financials with quite a few punches, causing analysts to cut their price targets.

Barrick Gold packed its much anticipated second quarter financials with quite a few punches, causing analysts to cut their price targets.

While the world’s largest gold producer had previously said that second quarter production would be the lowest for the year, some unexpected updates include: cost increases and delays at Pascua-Lama, more setbacks at Lumwana, the shelving of the Cerro Casale and Donlin Creek projects and the revision of its gold and copper production base.

Barrick’s new president and CEO Jamie Sokalsky who was hired in June to bolster the major’s share price told analysts on a conference call that the developments at Pascua-Lama and Lumwana were disappointing but are his top priorities to fix.

To increase shareholder value, Sokalsky said he has implemented a more disciplined capital allocation strategy to maximize returns on investments and free cash flow by focusing on production from high quality assets.

As part of that strategy, the Toronto-based company has launched a full review of its mines and projects to assess their rates of return and ability to generate cash flow, with more details expected in the third quarter.

Preliminary results for the Pascua-Lama gold project, bordering Chile and Argentina, showed that the start-up cost is expected to be 50% to 60% higher than the previous estimate of US$4.7 to US$5 billion. In a press release, Barrick points to low contractor productivity, engineering and planning gaps, cost escalation and schedule extension as the cause of the capex blowout.

As a result, the start of the project has been pushed back 12 months to mid-2014. To date, the major has spent US$3 million on Pascua-Lama.

“In retrospect, the challenges that come with a project of this size and unique complexity were greater than anticipated and proved to be beyond the capabilities of the Barrick in-house construction team,” Sokalsky explained on the call.

To get the project back on track, Barrick is working to have its EPCM partner Fluor take on a larger proportion of Pascua-Lama’s construction management. It has also engaged another EPCM organization to provide an independent review of the project over the coming months.

The major says the revisions should not affect the project’s expected production levels, slated to average 800,000 to 850,000 oz gold and 35 million oz silver in the first full five years of operation. The mine has an estimated 25 year life.

Analyst Kerry Smith of Haywood Securities said in a July 27 note “the project delay did not surprise us but the magnitude of the capex did.” Barrick has increased the project’s capex estimate to US$7.5 billion to US$8 billion. This factored into Smith’s decision to lower Barrick’s price target by $3.50 to $50 per share. He maintains a sector outperform rating on the stock.

On the same day, CIBC World Markets’ analyst Alec Kodatsky wrote a note saying that the deferral of first metal from Pascua-Lama to 2014 had an adverse impact on his earnings estimates for next year and price target. Kodatsky lowered Barrick’s 12 to 18 month price target of $63 to $57 and rates the stock as a sector performer.

David Haughton, a BMO Capital Markets’ analyst, downgraded his target to $44 from $55, pointing to the higher assumed capital requirements and lower expectations at the Lumwana copper mine in Zambia.

Kodatsky wrote in his note: “When Lumwana posted its worst quarterly production ever during Q1, the market may have thought things could not get any worse.”

As it turns out, he says, the mine took a turn for the worse, with second quarter copper production coming in 12% lower at 36 million lb and C1 cash costs increasing by 12% to US$3.53 per lb over the first quarter.

The miner explains Lumwana’s production and C1 cash costs have been negatively impacted by a historical waste stripping deficit. It adds that second-quarter output was further affected by planned mill maintenance, poor ground conditions and lower equipment availability as a result of the rainy season.

Lumwana’s poor performance drove the company to revise its copper guidance for 2012. It expects to produce 460 million to 500 million lb at C1 cash costs of between US$2.10 and US$2.30 per lb for the year. Of which, Lumwana is expected to contribute 145 million to 165 million lb at cash costs of US$3.30 to US$3.50 per lb, down from 230 million to 260 million lb at cash costs of US$2.40 to US$2.75 per lb.

“We are enduring some short term pain right now to maximize the long term value of the mine, and we will start to see that long term value surface in 2013,” Sokalsky commented.

To unlock that value, the company has implemented several initiatives including: increasing waste stripping, migrating to owner maintenance to enhance maintenance practices and equipment availability, and making leadership changes at site.

In addition, the gold major plans to advance work at the mine’s Chimiwungo pit, which grades higher than the Malundwe pit which is currently being mined. “About two-thirds of our production in 2013 will come from Chimiwungo, and that is where we see the potential,” Sokalsky said.

As part of the top-to-bottom review of all its assets, Barrick has evaluated its next tier of projects and found that the Cerro Casale copper-gold project in Chile, a 75-25 joint venture with Kinross Gold and the Donlin Creek project in Alaska, a 50-50 joint venture with NovaGold did not meet its investment criteria because of their substantial capital requirements.

While the Toronto-based producer plans to continue advancing both projects, it says it won’t make a construction decision on either project under current market conditions. As well as the company is scrapping small projects planned across the organization that require relatively small investments to add incremental ounces with little economic benefit, Smith of Haywood writes.

As a result, Barrick has lowered its annual gold production base to 8 million oz by 2015 once Pueblo Viejo in the Dominican Republic and Pascua-Lama are in full swing, down from the 9 million oz target it had in 2016. For copper, it expects annual production of 600 million lb by 2013, down from its 1 billion lb target by 2017.

Amid the gloomy updates, Pueblo Viejo, 60%-held by Barrick and the rest by Goldcorp, and Jabal Sayid, the copper project in Saudi Arabia, were pleasant surprises. Barrick announced construction on both projects are essentially complete and within budget. The miner expects first gold from Pueblo Viejo in August, and initial copper production from Jabal Sayid by September.

For the year, Barrick has reaffirmed its gold production guidance of 7.3 million to 7.8 million oz., however upped is total cash costs to US$550 to US$575 per oz from US$520 to US$560 per oz.

Total capital expenditures for the year are now anticipated at US$6 billion to US$6.3 billion.

For the second quarter, the company produced 1.74 million oz gold at a total cash cost of US$613 per oz, and 109 million lb copper at a C1 cash cost of US$2.28 per lb, missing its guidance on an annualized basis.

Net earnings were US$750 million compared to US$1.16 billion in the year-ago quarter. Adjusted net earnings were US$784 million, down from US$1.12 billion in the prior year quarter.

The company’s stock closed July 27 down 2% at $32.49, after losing 4% on the financial results the day prior.

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