powered by GlobeinvestorGold.com

Mathew Ingram

In this Issue

Hedged in

Mathew Ingram

TORONTO (GlobeinvestorGOLD)—Not that long ago, Barrick Gold Corp. was in the top tier of global gold companies. In fact, it was probably the most respected producer in the industry, and its shares received a premium valuation as a result. Has that situation now reversed itself, to the point where Barrick is being unfairly penalized? A case could be made that it has.

The key to Barrick's reversal of fortune, not surprisingly, is the price of gold. When the price of bullion was low, as it was for much of the 1980s and 1990s, Barrick's aggressive hedging program—which was pioneered by current Chief Executive Randall Oliphant—made it far more profitable than most of its peers, who were exposed to the spot price.

Barrick, however, managed to negotiate forward contracts that locked in relatively high prices for its production, and the use of this hedge "book" helped produce billions more in profits than the company would otherwise have had. The dependability of this strategy was the main reason for the premium on Barrick shares.

Unfortunately for Barrick, however, the price of gold couldn't stay down in the mid-$200 range forever, and as it's risen over the past year or so to the upper $300 level, Barrick's hedging program has changed from being a benefit to a liability. That has been one of the main factors depressing its share price, while shares of its competitors such as Placer Dome Inc.—which doesn't have a big hedge book—have risen.

In fact, in December alone the share price of Placer Dome climbed by more than 29 per cent, while Barrick's stock rose by only 7 per cent. Part of the reason for Placer's rise is that it recently completed its takeover of Australia's AurionGold Ltd., substantially increasing its asset base. But the company has also benefited from a flight of investors toward gold producers that are exposed to gold spot prices, because of the profit leverage that provides.

That's why earlier this month Barrick's stock was down 12 per cent from January of last year, while the Toronto Stock Exchange gold index was up 23 per cent in the same period, and some producers such as Newmont Mining Corp.—now the world's largest producer after its merger with Normandy Mining Ltd.—has risen by about 40 per cent. Barrick has been reducing its hedge position and has pledged to shrink it even further, but that takes time.

Barrick also lost some of the market's trust in September, when it came out with a surprise profit warning, saying production problems at several mines would cut its year-end profit by as much as 30 per cent. This was a shock for many investors, who had become used to the company outperforming, or at least meeting, its estimates like clockwork. The combination of that and the market's fear about the impact of hedging on Barrick's profit has kept the stock under pressure.

Still, there are analysts who believe that investors have overreacted to the hedging issue, and that based on Barrick's forecasts for the next two years, the company's growth prospects justify a substantially higher share price. According to Merrill Lynch, for example, Barrick deserves a premium valuation because of its "above-average growth prospects going forward." By using a multiple of 2.5 times enterprise value, Merrill comes up with a target price for the stock of $22 (U.S.), versus about $16.50 at the end of January.

Dundee Securities said that the stock has been a "chronic underperformer over the past three months, mostly as a result of misconceptions regarding their prodigious hedge book," and that the brokerage believes "investor sentiment will slowly change as Barrick shows that it can deliver at spot prices." Dundee says it's looking for a 12-month share price of $41 (Canadian) and has a "strong buy" rating on the stock.

Bear Stearns, meanwhile, said in a report last month that all the negative news about Barrick has already been reflected in the stock price, and that the company "continues to maintain a superior balance sheet, an enormous reserve base, a more global presence, diversified country risk, and strong organic growth prospects that few can match." The firm maintained its "market overweight" rating and target of $21 (U.S.).

Mathew Ingram joined The Globe and Mail's online news team in June of 2000, after spending four years as the Western business columnist, based in Calgary.

Back to top