Option Trade of the Week 
Barrick Gold Corporation (USA) (NYSE:ABX) Call
Wednesday, May 13, 2015

**OPTION TRADE OF THE WEEK: Buy the ABX Jan 2016 13.000 call (ABX160115C00013000) at or under $1.40, good for the day. Place a protective stop limit at $0.55 and a pre-determined sell at $2.80.

by Ian Harvey

Wednesday, May 13, 2015

Introduction

The option trade of the week is based on the fact that sentiment in gold has become extremely bearish -- four years after it topped at $1,900 per ounce, gold has been languishing in a range closer to $1,200. With interest rates low and most measures registering no inflation, gold seemed to be a dead asset. Its role as a hedge was dismissed by almost everyone except for the gold sellers.

But there are plenty of reasons for gold prices to increase, as discussed in the article “Gold To Make A Comeback!” - and Barrick Gold Corporation (USA) (NYSE: ABX), an operator of mines and advanced exploration and development projects, is certainly positioned well to take full advantage of this situation.

Barrick Gold Corporation is the world’s largest gold producer. Besides producing and selling gold, it also produces and sells significant amounts of copper. The Company operates mines or projects in Canada, the United States, the Dominican Republic, Australia, Papua New Guinea, Peru, Chile, Argentina, Zambia, Saudi Arabia and Tanzania. Barrick has the largest quantity of gold reserves, totaling 93 million ounces as of December 2014. It also has 9.6 billion pounds of copper reserves.

Due to the high reserve grade Barrick has a huge edge when it comes to cash costs, as its all-in sustaining costs is the lowest out of all the major gold producers. In fact, Barrick has one of the lowest AISC in the industry. That's a pretty powerful combination when not only are they the largest gold producer in the world, but also have one of the lowest cost structures in the sector.

And this Toronto-based, international miner looks ready to break out as can be observed in the chart below, where a double-bottom pattern is evident, which has been in development since October.

A double-bottom pattern takes the shape of a capital letter "W" on the charts with two similar lows and a leak in between. ABX's "W" is a bit flattened, but that does not diminish its meaning. The buy signal happens when the stock moves above resistance provided by the center peak of the pattern, which is $13.30 in this case.

The stock spends several days pausing below resistance before pushing through it which provides a positive effect. This is similar to a "handle" formation in a cup-and-handle pattern, and it is usually a reliable one to follow. A breakout from a pause tells us the market had a real shift from apathy to bullishness, which is better than a breakout occurring on momentum alone. The latter can often be an overshoot and a false signal.

Technical Outlook

Barrick Gold Corp. traded up 0.39% during trading on Tuesday, hitting $12.83. 6.28 million shares of the company’s stock traded hands.

Barrick Gold has a 52 week low of $10.04 and a 52 week high of $19.49.

The stock has a 50-day moving average of $12.84 and a 200-day moving average of $12.82.

The company’s market cap is $14.94 billion.

Earnings

Barrick Gold last announced its earnings results on Monday, April 27th. The company reported $0.05 earnings per share (EPS) for the quarter, missing the consensus estimate of $0.09 by $0.04. The company had revenue of $2.25 billion for the quarter, compared to the consensus estimate of $2.48 billion.

During the same quarter in the previous year, the company posted $0.20 earnings per share. The company’s revenue for the quarter was down 15.2% on a year-over-year basis. On average, analysts predict that Barrick Gold Co. will post $0.530 earnings per share for the current fiscal year.

The silver lining of this earnings report is that Barrick Gold increased its copper production in the past quarter by 13.5%. Also, the company revised up its production quota from an average of 325 million pounds of copper to 500 million pounds - a 53% bump. The rise in copper production is related to the decision to keep producing copper from the Lumwana mine despite the higher tax costs imposed by Zambia's government at the time. The company also brought down its cash cost of producing copper. Therefore, the operating cash flow-to-sales ratio, which measures the company’s ability to generate consistent cash from its operations, shows that Barrick is still capable of generating a good amount of cash from its operations.

In the earnings report, the company also cut down again its capex by $100 million, on average, to $1,950 million. Considering gold and copper prices remain low and the Pascua-Lama mine is still stuck, the company's decision to reduce its capex is reasonable. Also, this will enable Barrick Gold to move forward in cutting down its debt burden.

Even though Barrick faced cash problems in 2013, the company’s profitability, after controlling for its goodwill provisions, was relatively high and reached around 32.7%, due to low all-in sustaining costs. In comparison, Yamana and Goldcorp recorded a profit margin of around 16% (after controlling goodwill charges).

Future Plans

Barrick Gold touched upon its near-term project pipeline during its 1Q15 earnings call. It has completed a pre-feasibility study at Turquoise Ridge and expects to complete three more pre-feasibility studies on Nevada-based projects in 2015. Most of these are for higher-grade underground mines, which should help the company generate stronger margins along with volume growth.

Other Areas of Growth

• The company says that it has discovered a potentially attractive gold deposit at Alturas in Chile.

• The Zambian government has proposed amendments to the tax regime -- replacing the 20% rate with a rate of 9%. At this revised rate, Barrick Gold says it can generate positive free cash flow at current copper prices.

• Barrick is also partnering with QPX (Quantum Pacific Exploration), a company that uses innovative strategies to increase the probability of copper discovery.

• The company started to build its Jabal Sayid copper mine in Saudi Arabia and estimates production will commence at the beginning of 2016. The annual production is expected to reach at first 100 million pounds and could ramp up to 130 million pounds.

Initiatives in Progress

Value Realization Project

Barrick has also launched the "Value Realization Project", which is basically a top to bottom analysis of operations that it owns. The purpose is to find ways to maximize free cash flow by looking at the economic potential of every mine and identify specific projects that could help lower costs and/or increase production.

Reassessing Capex Budgets

Barrick Gold is reassessing its 2015–2016 capital budget with a view to making capital allocation stricter. The company says it will review individual projects against a hurdle rate of 15%.

Barrick expects the ROIC (return on invested capital) on its overall portfolio to be 10% to 15% over the metal price cycle. The company’s compensation plan is also weighed by 20% toward meeting annual 10% to 15% ROIC targets.

The company will defer, close, or sell the projects not meeting this criterion. Existing operations, including sustained capital expenditures, will also have to compete for capital.

Tackling Barrick Gold Debt

During its 1Q15 earnings call, Barrick Gold reiterated its three-pronged approach to achieving its number-one priority—deleveraging its balance sheet by $3 billion in 2015. If this is accomplished the way it plans to, Barrick stock could be re-rated.

Maximizing Cash Flow

To maximize cash flow, Barrick is focusing on more efficient capital spending, reduced general and administrative costs, and profitable growth. With this approach, Barrick expects to save $30 million on G&A (general and administrative expenses) and overhead in 2015 and $70 million by 2017.

According to the initial capital review, Barrick has identified $200 million in capital expenditure cuts for 2015. It’s also deferring infill drilling that only adds minimal additional ounces. Finally, it’s assessing and optimizing on-site headcount reductions.

Non-core Asset Sales

Barrick has already stated its intent to sell its Porgera JV (joint venture) in Papua New Guinea and its Cowal mine in Australia. In line with due diligence requirements, site visits are being conducted with prospective buyers. A number of companies are involved in the process of selling these mines.

JVs and Strategic Partnerships

The company says that it will enter into joint ventures and strategic partnerships only if they make sense. In keeping with this approach, Barrick has initiated a process to sell a stake in Zaldivar mine. It’s also exploring other similar opportunities.

Hedge Funds Interests

David B. Iben’s Kopernik Global Investors has filed its 13F for the reporting period as of the end of the first quarter of 2015. And Barrick Gold Corporation (USA) is the largest basic materials stock holding of Kopernik. The fund had an investment of $57.46 million in Barrick Gold consisting of 5.24 million shares of the company, which accounted for 14.39% of the fund’s portfolio.

Also, First Eagle Investment Management, Renaissance Technologies, and D E Shaw are among the funds holding large positions in Barrick Gold Corporation.

Analysts Opinions

Barrick Gold had its “buy” rating reaffirmed by analysts at TD Securities on May 2nd. They now have a $17.50 price target on the stock, up previously from $16.50.

Also, on the same day, Barrick Gold had its “hold” rating reaffirmed by analysts at Jefferies Group. They now have a $12.00 price target on the stock.

They wrote….

“Despite a weak 1Q, the company expects to meet full year production guidance as production should be weighted to 2H15. Barrick reports that the strategic initiatives it rolled out at the beginning of the year are advancing as planned. Further progress on these initiatives would be encouraging and would likely push the ABX share price higher.”

On the 29th April, Barrick Gold had its target price lifted by Canaccord Genuity from C$12.00 to C$12.50. They currently have a sell rating on the stock.

The company has also been the subject of a number of other research reports:-

• Analysts at Credit Suisse Group AG initiated coverage on shares of Barrick Gold Corp. in a research note on Thursday, April 23rd. They set a neutral rating and a C$13.00 price target on the stock.

• Analysts at Dundee Securities raised their price target on shares of Barrick Gold Corp. from C$14.00 to C$17.00 in a research note on Monday, April 13th.

• Analysts at Scotiabank reiterated a sector perform rating on shares of Barrick Gold Corp. in a research note on Friday, February 20th.

• Finally, analysts at Jefferies Group initiated coverage on shares of Barrick Gold Corp. in a research note on Friday, February 20th. They set a hold rating on the stock.

One investment analyst has rated the stock with a sell rating, seven have given a hold rating and two have issued a buy rating to the stock. The stock has a consensus rating of Hold and an average target price of C$18.06.

Conclusion

Barrick Gold has the operating cash flow to reduce its debt burden. It has this luxury because it owns the best gold assets on the planet. This operating cash flow gives it more financial flexibility, as it can monetize these cash generating assets as well.

It should also be remembered that this debt is longer term in nature; Barrick doesn't have any substantial payments due during the next three years. Even if you include interest, the company can cover all of it with cash on hand during that time.

But Barrick is being proactive; it is going to start paying down the debt this year. And if it can generate $3-$5 billion from sales of non-core operations, its core operations are going to be worth a lot more in the future – which means that the bears are misreading this situation.

By cutting the net debt down to $7.1 billion, it will also see a big reduction in annual interest payments to the tune of $150 million. It is also reducing G&A as well as other expenses, which should save the company at least another couple hundred million annually.

All of these steps taken should result in Barrick generating free cash flow in 2015. This can be done without getting rid of any core mines that the company owns. That speaks volumes for the quality of the assets that Barrick has in its portfolio.

Barrick Gold has made several changes in order to ease its financial burden mainly by cutting down its capital expenditure and slowing down its production. Moreover, the company’s current valuation seems lower than its peers. If the gold market continues to recover, Barrick Gold will benefit from this rally, which is perfect for this option trade of the week.

Therefore, based on the facts above the following option trade of the week is recommended…..


**OPTION TRADE OF THE WEEK: Buy the ABX Jan 2016 13.000 call (ABX160115C00013000) at or under $1.40, good for the day. Place a protective stop limit at $0.55 and a pre-determined sell at $2.80.

Please Note: This is a recommendation, but it is up to the individual trader to consider when to enter the trade, adjust the stop-loss and pre-determined sell positions, according to his/her risk tolerance!



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