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Big bets on the bottom-line

March 27, 2013
Big bets on the bottom-line
Jamie Sokalsky

Project cost over-runs. Delays and missed deadlines. Lower than expected production. These are headlines that have dominated the mining industry recently, translating into a common investor sentiment that many miners have simply not been disciplined enough with investment over the past several years, says  Barrick Gold CEO Jamie Sokalsky

“If we look back two, three, four years ago, many investors’ focus was on increasing gold production. They rewarded miners who touted significant production growth. And for the most part, shareholders ended-up getting a lot of what they asked for — miners making investments to grow production for the sake of production growth,” says Jamie.

But the industry wasn’t disciplined enough and many investors were left disappointed with mine performance and investment returns. “I think the gold industry has gone through a bit of sea-change. Now, miners are more focused on the bottom-line. The industry overall is becoming a lot more disciplined in terms of the capital we are spending,” shares Jamie. This shift in business strategy from one focused predominantly on increasing production to a strategy focused on increasing the rate of return on each ounce produced is mining executives’ way of proving to investors they are buckling down, being disciplined and focusing on the bottom-line not the top-line. Jamie emphasizes this stating, “There is much more focus now on free cash-flow per ounce than there is on operating cash-flow margins. Shareholders aren’t as focused on operating cash-flow margin as they are on real cash generated from the business.”  Barrick’s strategy of being more focused on returns and free cash-flow is resonating with investors and is being embraced by other companies in the industry.

With notable pressure on mining executives to turn their backs on low return investments, investors can expect to reap the rewards of a more disciplined capital allocation strategy down the road. Results won’t be noticed overnight. The damage that has already been done must be undone or compensated for before significant benefits are enjoyed.

 “Our message is that Barrick’s approach is not just a harvest type strategy — that we do need to reinvest in the business, but we have to reinvest at attractive rates of returns, it is not okay just to invest to generate greater ounces. Barrick is focused on bottom-line growth on a per share basis. If we can control our operating and capital costs, generate higher quality ounces and make higher returns on investment — even if that means not growing our ounces produced — then that’s what our strategy should focus on,” says Jamie.

Investors want exposure to the strong price of gold without the risks mining companies face. As a result, gold exchange traded funds (ETFs) and gold streaming companies have notably attracted the attention of said investors. “We have seen a gradual increase in gold ETFs. Even in the phase of fairly significant sell offs in the gold price there hasn’t been wholesale selling. To me, that indicates that these are primarily core investments for certain investors as part of their portfolio. As gold is viewed as more and more like a currency and core to a portfolio for individuals and other institutions, ETFs won’t end up being a bubble,” shares Jamie. “As a gold industry we need to recognize there is increased competition not just from other gold miners, but with other gold investment opportunities like ETFs that tout protection from mining risks such as strikes, resource nationalism, and cost overruns.”  Jamie argues that increased discipline needs to be mining executives selling proposition in order to bring investment back to gold mining companies. Jamie emphasizes this stating, “Our focus is on disciplined capital allocation and running the business well to compete against a multitude of general businesses, and then when the gold price goes up gold miners should hit a home run”.

And Jamie expects just that to happen. Stating the long-term trend for the price of gold is up, and we could see prices in excess of $2,000 and higher within a year or so. “We don’t just want to appeal to gold bugs excited about the price of gold,” says Jamie. “We want to attract investment flows because we run the business well and that won’t happen if we misallocate capital.” 

Investors are also placing increased importance on social responsibility, rewarding companies who have strong corporate social responsibility (CSR) policies. “Ultimately, it is not just about doing the right things from a socially responsible standpoint, it is about good business. When investors see that we’re trying to do things right from a government relations, community relations, and environmental standpoint it’s a competitive advantage — especially when operating in more challenging countries”, says Jamie. The industry has seen many instances where miners haven’t been able to move investments ahead because of government and community resistance. This has a significant negative impact on miners’ stock performance. I believe the importance investors place on an effective CSR strategy will only continue to increase,” states Jamie. This increased emphasis on CSR will bode well for mining companies and investors.

So, while investors remain drawn to gold, they are disappointed with gold miners. To attract investor capital, Barrick is concentrating on two key metrics: free cash-flow per ounce and risk adjusted returns on capital. Returns will drive production. Production will not drive returns.

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