Barrick Gold: Don't Buy The Rip

In our previous article in December, we encouraged investors to wait for a steep pullback in Barrick Gold Corporation (NYSE:GOLD) stock before jumping back on board.

As a reminder, we upgraded GOLD to a Buy rating in September, emphasizing that it was near its "peak pessimism." Accordingly, it has outperformed the S&P 500 (SPX) (SPY) since then, notching a total return of nearly 40%, compared to the SPX's 4.2% uptick.

However, GOLD fell after notching its early February highs, declining nearly 20% toward its March lows. As such, investors were afforded the opportunity to buy the plunge in early March as the fearful investors parsed the fallout from the recent banking crisis.

The fear has proved unfounded, as the contagion risks were likely overstated. JPMorgan (JPM) CEO Jamie Dimon also stressed in his recent annual letter that "the current situation is not comparable to the 2008 financial crisis." Moreover, financial insiders in the Financial Select Sector SPDR ETF (XLF) have also put their money where their mouth is, as they scooped up their shares from investors who fled.

As such, GOLD and its gold mining peers, represented in the VanEck Gold Miners ETF (GDX) and iShares MSCI Global Gold Miners ETF (RING), saw their stock bolstered by the sharp recovery in gold prices.

The long-term chart of GC1/DXY shows that the US Dollar Index (DXY) has underperformed against the resurgence in gold prices since September 2022. Notably, the pessimism in gold prices and outlook reached a peak in September, as it formed a bear trap or false downside breakdown as gold sellers fled in a hurry in response to the Fed's rapid rate hikes.

That bear trap has played out accordingly, as GC1/DXY mean-reverted. As such, by the time you read this (and if you didn't capitalize on GOLD's deep pullbacks in September and March), your reward-to-risk profile is much less attractive now.

Morningstar rates gold miners as stocks with no sustainable economic moat. These companies possess highly volatile profitability margins impacted by the economic cycles.

Barrick Gold's adjusted net margins are expected to improve through FY25, suggesting Wall Street analysts are not expecting gold prices to fall below the lows last seen in 2022.

Moreover, the company is confident its costs could be mitigated by falling energy prices this year. However, the recent surge in underlying crude oil prices (CL1:COM) (USO) must be watched carefully, as they appear to be potentially resuming their secular uptrend.

Despite that, the recent surge in gold prices could still mitigate the downside risks to its costs if it can be sustained. Moreover, as a gold miner, the company has significant operating leverage given its CapEx margins, as seen above.

It posted a TTM CapEx margin of about 27.7%. However, weak gold prices resulted in a TTM free cash flow or FCF margin of just 3.9% in FQ4'22. Barrick Gold is expected to post an FCF margin of 9.4% in FY23 before improving further to 13.8% in FY24.

Given the recent improvement in underlying prices, we believe analysts could subsequently mark up their forward estimates if they could be maintained.

However, has the market priced in the recent optimism?

Based on GOLD's blended fair value estimate, it has a 13% upside to its implied fair value. However, a closer look at its valuation metrics suggests that the DCF models could have overstated its blended fair value estimate.

As we highlighted earlier, the DCF models consider the markedly improving FCF projections over the next few years. Therefore, investors will likely need to factor in a more considerable margin of safety to reflect these uncertainties.

Trefis' sum-of-the-part or SOTP valuation suggests that more than 75% of GOLD's valuation is predicated on the performance of its North American gold mines.

Barrick Gold announced recently that its Nevada Gold Mines "is showing significant mineral resource growth and new discoveries" as it forms "the value foundation of Barrick." Therefore, investors should continue to monitor its performance, given the outsized valuation impact the market could consider on GOLD's valuation.

We don't observe an optimal buy point at the current levels, as buyers rushed in since GOLD bottomed out in March.

Moreover, Morningstar's peer analysis suggests no valuation dislocation, as Newmont (NEM) trades at a 23% premium and Agnico Eagle Mines (AEM) at a 34% premium.

Given the sharp recovery recently, we don't think there's a lower-risk entry point to add more positions here.

Hence, we urge investors not to chase the momentum spike. Instead, they should consider waiting for the next steep pullback before pulling the Buy trigger.

Rating: Hold (Reiterated).

Important note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. The rating is also not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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