African Barrick Gold SBM Conviction Buy Update

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We wrote about ABG some weeks ago now when the stock was trading around 230p following the breakdown of takeover talks which China National Gold who had planned to buy the majority stake in the company from parent shareholder Barrick Gold. Since that point, it has largely been one way traffic with the stock finishing with a 1 handle at the close of play yesterday. We cover the valuation case extensively in the latest edition of our magazine (page – 18) –

From a technical perspective, it has pretty much hit the target that was suggested by our resident technician Zak Mir only 5 weeks ago (see here – The stock was then dramatically oversold and is now stupidly oversold as we can see on the updated chart below. In fact, it’s about the most oversold chart I’ve seen since the turn of the millennium when the “old economy” stocks were trading on valuations not since the 70’s. Take a look at our piece below on the Gold Mining sector as a whole to get a bigger picture as to the historic valuation opportunity that is now present in the sector.

We re-iterate the reasons why ABG has been made a Conviction Buy

1. In their last earnings report, excluding exceptional items, the stock would have produced an EPS of around 26c – 17p at current FX rates. These results were depressed through a combination of lower production at its flagship Bulyanhulu mine as it was hit by a strike and also rising cash mining costs which increased at an unuseful 37 percent from their 2011 level to $949/oz. Going forward, the strike issue looks to be resolved and management have made a great play about containing costs.

With the forecast range of $925-$975/oz, then at the current gold price EPS could rebound sharply into 2014 although the near term figures for YE 2013 is likely to remain at muted levels given reduced production. Still, an EPS figure of 45p was delivered for 2011 and if management can contain costs and ramp production up into 2014 then at 198p the stock could be on a PE of just 5 times.

2. What we really like is the fact that the company was listed at 575p a share just under 3 years ago with similar gold gross margins to today. Is the company really worth half the amount? Factor in that China Gold saw value in the company when the price was trading around 350p per share and they were prepared to pay a control premium. It seems Canadian parent Barrick Gold was holding out for 500p+ as a fair value and, as we will see below re the tangible book, I have some sympathy with this value. At the current price, the stock is trading at half the value of what both parties saw as fair – parties who know the industry inside out.

3. Even on the depressed earnings plane of YE 2012 with EBITDA down almost 40%, with a market cap of £950m and net cash of circa £270m at the current FX rates, the shares trade on an EV:EBITDA multiple of under 3 times – one of the lowest in the sector. Get the EBITDA up and these look exceptionally cheap.

4. The stock is yielding a healthy 5% providing additional valuation support.

5. At the current price, stripping out goodwill and using our favoured valuation for asset backed business, the shares trade on a price to net tangible book value (£1.6bn) of just under – 0.5 times now – again, excluding the likes of AVM, this is one of the lowest in the global sector.

4. Finally, the majority of “anal”ysts are now negative on the company – per usual reacting to the decline as opposed to anticipating. This, as regular readers will know, is a comforting factor to us and we prefer to be in the minority as it means the majority is yet to buy and provide our profit tail wind!

Similar to AVM, barring a collapse in the gold price to $1000/oz there is no way we can get anywhere near the current price. This doesn’t mean that the stock will rebound overnight but, what is does mean, is that for the patient, the downside is, in our opinion, much less than the potential upside – postive skew as we call it. Accordingly we remain long and look for a value of 300p+ in the weeks ahead.

There’s one final thing to consider too and that is should the stock drop much further, considering Canadian Barrick hold 74%, there is a very real chance that they could try and buy out the minorities. After all, if they felt the stock worth north of 500p and they can buy back for 320-350p at a major cyclical low in the sector why would they not?

2 Year daily chart 

It seems to us that we are currently in the process of transfer of ownership from the disillusioned and over margined to the patient and value players – history shows which invariably wins out. Remember, the game is to buy low and sell high not buy high and hope to sell higher. As with RPO – fear and uncertainty is what creates the value opportunity.

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