Analysis: Slumping gold price leaves Barrick with uncomfortable options

China Gold International Resources

18/04/2013 18:19

* Credit rating downgrades are possible

* Slumping gold price will hurt Barrick's cash flow

* Dividend cut is among the company's options

* Cost to insure Barrick debt against default spikes

* Barrick may have start hedging some output again

By Euan Rocha and Allison Martell

TORONTO, April 18 (Reuters) - Barrick Gold Corp  ABX.TO

ABX.N  may have little choice but to cut its dividend, freeze capital spending or reopen a gold hedge book, as tumbling gold prices add to the already formidable list of issues dogging the world's biggest gold producer.

The company, which reports quarterly results on April 24, has been plagued by delays and mounting costs at many of its biggest projects. To make matters worse, it carries a net debt load of $11.6 billion, as of year end-2012, and faces the threat of a further credit rating downgrade.

"Mathematically, as the gold price falls, they lose wiggle room. That's undeniable," said Elizabeth Collins an analyst with Morningstar. "And in terms of sentiment, people were very agreeable to lending Barrick money when gold was in favor. But as gold falls out of favor that might change."

Shareholders of Toronto-based Barrick have had a rough ride in the last two years. The stock, now at a 20-year low in Toronto, has more than halved in value in the last year alone.

Its unpopular $7.3 billion acquisition of Equinox Minerals in 2011 has not lived up to expectations and the company shook up management after costs to build its huge Pascua-Lama project on the Chile-Argentina border jumped from under $3.5 billion in 2011, to the latest estimate of up to $8.5 billion.

The recent slump in the price of gold, days after a Chilean court ruling forced Barrick to partially suspend construction work at Pascua-Lama, just adds to its list of woes, including problems with properties that were a part of the Equinox deal.

"Their woes commenced with the Equinox acquisition," said John Goldsmith, the deputy head of equities at Montrusco Bolton Investments Inc. "We were shareholders until that deal and after Equinox we thought, you know what this makes no sense any more."

Perhaps, a bigger concern for investors now is the Dominican Republic's attempt to squeeze more tax money out of Barrick as it ramps up output from its recently completed Pueblo Viejo gold mine there. The $4 billion mine is a joint venture with Goldcorp Inc G.TO .  ID:nL1N0BR9J2

The massive capital outlay for projects like Pascua Lama and Pueblo Viejo, puts Barrick in a tough spot, says Stifel Nicolaus analyst George Topping.

"In an environment of falling gold prices, Barrick is one of the worst positioned due to its high debt," said Topping, adding that if gold falls to $1,200 an ounce, Barrick would spend 27 percent of its 2014 cash flow on interest payments alone.

"If gold prices don't pick up they are indeed at risk of more credit (rating) downgrades, and certainly within the market that's what investors are most worried about."

Spot gold dipped close to $l,320 on Monday, a two-year low. It has partially pared its losses and was at about $1,390 on Thursday.

The plunge in the gold price and uncertainty at Pascua Lama, pushed Moody's on Wednesday to put $7.5 billion of Barrick's debt under review for a possible downgrade.  ID:nMDY4M4Gbv

Barrick played down concerns about a rating cut, saying it is one of the lowest cost gold producers and it generates large operating cash flows at present gold prices.

"Should a downgrade occur, Barrick will continue to have an investment grade rating with considerable financial flexibility and excellent access to debt capital markets," said Andy Lloyd, a spokesman for the company.

Standard & Poor's already downgraded the company's debt by a notch last July and warned that further cuts were possible.

MASSIVE DEBT LOAD

Barrick has issued about $9 billion in debt since early 2009 to finance acquisitions, unwind a previous gold hedging strategy and fund construction of Pascua Lama and Pueblo Viejo.

The company has just over $3 billion in debt repayments due in 2013 and 2014, plus interest payments of about $1.2 billion. Barrick has roughly $2 billion in cash for now, and access to a similar amount remaining under a credit facility.

Barrick intends to continue construction work on Pascua Lama

and potentially sink another $4 billion into the mine, saying it still sees the project as a top priority, as it will be one of the world's lowest operating cost mines once built. But analysts and investors question the wisdom of this, as time-lines and a pay-back from the project remain uncertain for now.

While Barrick is not in danger of defaulting on its debt at this time, the cost to insure its debt is at its highest in over two years. Five-year credit default swaps in Barrick have now widened by 72 basis points to 225 basis points in the last week. It now costs about $225,000 a year, for five years to insure $10 million of Barrick's debt, according to data from Markit Group.

Greg Barnes of TD Securities estimates that the company's net debt-to-earnings before interest, taxes, depreciation and amortization ratio is likely to spike to 2.4 times this year. He sees the ratio rising to 2.8 times at a gold price of $1,300 per ounce, and 3.2 times at $1,200 per ounce.

When S&P downgraded Barrick's debt to BBB+ in July, it said it would cut its rating further if the company's debt-to-EBITDA ratio neared a 3 multiple.  ID:nWNA2235

To be sure, Barrick is not in as deep a crisis as its fellow Canadian miner Teck Resources  TCKb.TO  was in back in 2008 when it took on billions in debt to acquire Fording Canadian Coal. As the financial crisis unfolded and commodity prices plunged soon after the deal, Teck was forced to sell assets and take other drastic steps to right itself.

"I really don't think it's all that bad for Barrick. It is going to be a painful time right now, but they can definitely engineer their way out of this problem," said Goldsmith.

UNCOMFORTABLE OPTIONS

As pressure mounts, Barrick could cut its dividend as early as next week, when it reports first quarter results.

Another option for Barrick is to cut all growth spending before it considers reducing its dividend payout, following a strategy that two of the world's largest miners - Rio Tinto

RIO.AX  and BHP Billiton  BHP.AX  - have pursued.

"The dividend I think would be a last resort. I'd rather see them cut back on development of Pascua Lama," said Topping. "The dividend attracts investors whereas Pascua deters investors, so keep the one that brings them in."

Monetizing assets, and even a renewed push to sell its stake in African Barrick Gold  ABGL.L  remain options, but investors and analysts say a fire sale of assets, merely to appease credit rating agency concerns, may not be the smartest move.

That may leave Barrick, which declined to comment on whether it would consider any of these options, with having to look at another strategy that was not very long ago unthinkable.

"I hate to use the 'H' word, but there is nothing preventing Barrick from using options, like hedging production for the next two years," said Montrusco's Goldsmith.  ID:nL5N0CJ3BB

Hedging through selling production forward was a popular way for miners to lock in prices in the late 1990s and early 2000s. But hedging got a bad reputation in the last decade, as the gold price soared from $250 an ounce in 2000 to a record of $1,920.30 in 2011, and hedged miners lost out on much of the upside.

Barrick itself spent billions a few years ago to unwind its hedge book. Barrick said it has no plans to hedge gold, but with challenges growing it may be left with few options.

"Hedging is typically used, when you want to guarantee the cash flow payback on a project and it is used in times of duress and I am pretty confident in saying that now is a time of duress for Barrick," said Goldsmith.

(Reporting by Euan Rocha and Allison Martell; Editing by Frank McGurty, Janet Guttsman and Tim Dobbyn)

((euan.rocha@thomsonreuters.com)(+1 416 941 8185)(Reuters Messaging: euan.rocha.reuters.com@reuters.net))

Keywords: BARRICK STORM/