Barrick Gold Will Take $5.5 Billion Impairment Charge On Chilean Mine

Barrick Gold Corporation‘s (NYSE:ABX) has announced that based on preliminary assessments, it expects to take an after-tax asset impairment charge of $4.5-5.5 billion in the second quarter for the Pascua Lama project. The impairment is mainly due to crashing prices of precious metals like gold and silver in the world market and the delay in first production at Pascua Lama. The company is still in the process of testing its other assets, including goodwill, for impairment. Hence, the final figure could be much higher. It is to be noted that Barrick has already spent about $5 billion in capital expenditure on Pascua Lama. ^[1]

The market had already been anticipating significant impairment charges for major mining companies, and this was reflected in the crashing prices of their stocks in the last few days. Therefore, we expect the announcement from Barrick to have an impact on its stock price proportional only to the difference between Barrick’s announced figure and the market consensus.

The Pascua Lama project is very important to Barrick’s future revenue stream and it has suffered one setback after another in the last 2-3 years. Capital expenditure has ballooned to almost three times the original estimate, construction has been delayed and a Chilean court has banned it from further development of the mine till it complies with 23 specific action steps outlined by the regulators. ((Chilean President gives Barrick Gold its Pascua-Lama fix-it orders, The Globe And Mail))

See Full Analysis for Barrick Gold Here

Pascua Lama’s Potential

According to the latest available figures, Pascua Lama has proven and probable reserves of 17.9 million ounces of gold, 676 million ounces of silver contained within the gold reserves, and a mine life of 25 years. Once production begins, Barrick expects to produce 0.80-0.85 million ounces of gold and 35 million ounces of silver annually. In 2012, the company had a total gold production of 7.42 million ounces of gold. It has been aiming at producing 8 million ounces by 2016, and Pascua Lama is integral to achieving this target. In light of the delays expected now, we think that it will miss this target. ((BMO Global Metals and Mining Conference, Barrick Gold Presentation))

Cost Profile

Once in operation, Pascua Lama is expected to be one of the world’s largest low cost mines and is expected to contribute significant free cash flow to Barrick for many years to come. It is expected to produce an average of 800,000-850,000 ounces of gold per year in its first full five years of production, accounting for almost 11% of Barrick’s revenues. ^[2]

In 2012, Barrick reported an all-in sustaining cash cost of $945 per ounce of gold. In contrast, the all-in sustaining cash cost at Pascua Lama is expected to be $50-200 per ounce. Including depreciation of capital expenditure incurred in mine construction, costs are not expected to exceed $550-700 per ounce. One must note that all cash cost estimates are based on gold, silver and West Texas Intermediate (WTI) oil price assumptions of $1,700 per ounce, $30 per ounce and $90 per barrel, respectively. Given the current gold price levels, we expect the company to provide revised figures based on new assumptions at the end of Q2.

Barrick estimates that its average all-in sustaining cash cost will increase to $950-1,050 per ounce in 2013. If Pascua Lama were coming into operation in 2014 as originally scheduled, this figure would have definitely gone down considerably. Now, that will have to wait another year and a half according to Barrick’s revised expectations. In the meantime, the company will find its margins squeezed due to high costs and low prices. ^[3]

Factors Responsible For Impairment

The prices of gold and silver tumbled last month, largely due to the announcement that the Federal Reserve may halt quantitative easing in the coming months. Last week, gold hit a three year low of $1,180 per ounce. The U.S. economy appears to be strengthening and money is flowing out of emerging markets back into the U.S. as future expectations strengthen. Within the U.S., money is flowing out of the relative safety of gold and silver into equities, thus exerting downward pressure on gold and silver prices. Since Barrick assumed a much higher level for gold prices at the beginning of the year, the book value of its assets is bound to have decreased, thus necessitating an impairment charge. ^[4]

Another factor specific to Pascua Lama is the revised schedule for first production from end of 2014 to mid-2016. This is due to a Chilean court ruling that suspension of the project till Barrick complies with regulatory demands. The company needs to carry out the construction of canals and drainage systems to divert run-off water away from the Pascua Lama mine. This is likely to take time.

As a result of delays, capital expenditures at Pascua-Lama for 2013 are expected to be reduced by approximately $700-800 million (which includes the $300 million in previously announced deferrals) to $1.8-2.0 billion. Capital expenditure in 2014 is expected to be reduced by approximately $0.8-1.0 billion to approximately $1.0-1.2 billion. The initially planned capital expenditure has been deferred, not cancelled. Barrick will re-sequence the construction of the project and provide an updated capital cost estimate in the third quarter.

The final impairment figure may be much higher than $5.5 billion due to further charges against other assets, including goodwill. It may well turn out to be the highest one-time impairment charge in history for a gold mining company. The highest figure so far stands at $5.5 billion, the quantum of hit Newcrest Mining took as impairment charges last week. ^[5]

We have updated our price estimate for Barrick Gold to $19 in view of gold prices observed in the last few weeks.

Understand How A Company’s Products Impact Its Stock at Trefis

1. Barrick Provides Updates on Pascua-Lama Project, Barrick News Release [↩]
2. Barrick Gold Delays Production at Pascua Lama Mine, Sets Big Charge, WSJ [↩]
3. Bank of America Merrill Lynch Global Metals, Mining & Steel Conference, Barrick Website [↩]
4. Gold Price Charts, Kitco [↩]
5. Miners’ writedowns top $17-billion as Roubini sees gold dropping to $1,000, Financial Post [↩]