TORONTO - A plan by Barrick Gold Corp. (TSX:ABX) to issue millions of new shares to pay for a move to eliminate its gold hedges will take a toll on the stock price of the world's biggest gold company, but is well worth it, analysts say.
Blackmont Capital analyst Richard Gray said the new shares will carry an immediate "steep cost" for Barrick, an assessment that appeared to be borne out Wednesday as shares in the company lost $2.74 or 6.5 per cent to $39.71 in heavy trading.
However, Gray lowered his target price for Barrick by just one per cent to $48.50 from $49 while maintaining his "outperform" rating on the stock, describing the hedge elimination as a "major, positive event."
"The elimination of the hedge improves the valuation of two of the company's major growth projects (Pueblo Viejo and Pascua-Lama) and more importantly, the marketability and optics of the world's largest gold producer," Gray commented.
"It removes a significant future liability that was becoming more difficult to defend with the increasing gold price."
The Toronto-based company said Wednesday it will issue 94.8 million common shares at US$36.95 per share to raise $3.5 billion, up from the $3 billion first announced.
The underwriters have also been granted an over-allotment option for an additional 14.21 million shares at the offering price that could bring the offering to $4 billion.
After the moves, Barrick will increase its share base from 873 million to 968 milllion shares outstanding, 982 million if the over-allotment option is fully exercised.
Haytham Hodaly, an analyst with Salman Partners, agreed the move would create "near-term pressure until a lot of the paper out of this transaction finds a safe home," but that it will make Barrick's shares more attractive to investors down the road.
"It'll be very positive because they'll be able to realize what many would have expected them not to realize, which is the actual spot price as we see it going through somewhat of an inflationary environment," Hodaly said.
The massive share offering came as the price of gold hovered around $1,000 an ounce for the first time since March 2008. On Wednesday, the December bullion contract on the New York Mercantile Exchange fell $2.70 to US$997.10 an ounce.
Barrick decided to eliminate its hedges because of an increasingly positive outlook on the gold price. Barrick also said it believes the gold hedges hurt its appeal to the broader investment community and the company's share price.
Gold hedges are futures contracts that commit a company to selling the precious metal at set prices. While hedges provide guaranteed cash flows in future, they often commit a producer to ship the gold at prices lower than the current spot price. That usually creates a big accounting loss on a company's books to reflect the lost revenue potential from the hedge contract during a time of rising spot prices.
Barrick began unwinding some of its hedging contracts more than two years ago in a move to cash in on rising gold prices.
As of Monday, Barrick's forward sales contracts, made up of the gold hedges as well as floating contracts, totalled 9.5 million ounces with a mark-to-market value of negative $5.6 billion.
The company, which has major mines in Canada, the United States, South America, Australia and Africa, said it will use $1.9 billion to eliminate all of its fixed priced gold contracts within the next year and $1.5 billion to eliminate a portion of its floating spot price gold contracts.
A $5.6-billion charge to earnings will be recorded in the third quarter as a result of a change in accounting treatment for the contracts.
In a prospectus filed Wednesday, Barrick said it expects 2009 gold production to be between 7.2 million and 7.6 million ounces, while 2010 gold production is expected to grow to between 7.7 million and 8.1 million ounces at lower total cash costs than 2009.
At full capacity, the Cortez Hills mine in Nevada, Pueblo Viejo in the Dominican Republic, Pascua-Lama on the border between Argentina and Chile, and Buzwagi in Tanzania are expected to contribute a total of 2.6 million ounces of gold annually at lower total cash costs than Barrick's current profile.