Questor share tip: Hold African Barrick Gold until bid situation becomes clear

By Garry White

African Barrick Gold shares have finally stopped their downward slide, as a bid approach brought gold equities back to life.

Questor noted yesterday that M&A now looked likely in the sector after valuations plunged to “derisory” levels. It looks like China has had the same idea.

Two state-owned companies have approached African Barrick Gold’s (ABG) parent company Barrick Gold with a view to making an offer for part, or whole, of ABG. Barrick Gold is continuing talks with China National Gold, after it apparently rejected a lowball bid from Zijin Mining Group.

If China National Gold buys more than 30pc of the voting rights of ABG, it has to make a full bid for the company. Questor thinks the more likely option is for Barrick Gold to sell part of its stake, rather than the entire holding, as the shares remain significantly below the 575p level at which they were spun off in May 2010.

Barrick Gold has a relatively new chief executive, Jamie Sokalsky, who is conducting a strategy review at the world’s largest gold miner. Mr Sokalsky’s stated mission is to improve returns from the company’s assets, instead of just focusing on increasing gold production.

“All capital allocation options, which include organic investment in exploration and projects, and acquisitions or divestitures to improve the quality of our portfolio, will be assessed on the basis of maximising risk-adjusted returns,” Barrick Gold stated alongside its second quarter results last month.

Extracting some value from Barrick Gold’s stake in ABG would slot nicely into this new strategy focusing on returns.

ABG’s shares have plunged because of some company-specific issues, but valuations across the sector have also slumped. This was happening when gold prices were close to record high last year — and it has continued as the price has stayed at about $1,600 an ounce and below since May.

The reasons the sector is unloved by investors are many. They include rising production costs crimping margins, operational problems with staff and equipment and the management of some companies over-promising in their production guidance.

There is also country risk, with companies such as Centamin Egypt being hit by the Arab Spring and a coup in Mali hitting shares in Randgold Resources earlier this year.

Also, the proliferation of exchange-traded funds (ETFs) has provided a direct investment in any gold price movements. This is perhaps the most important factor that has lured investors away from equities because there is no operational risk.

In response, a number of gold companies have now started to increase their dividends as a means to attract investors away from gold ETFs. Gold, after all, is a non-yielding asset. ABG’s current prospective yield is 2.3pc.

However, a re-rating of the sector to higher earnings multiples has not happened yet. Even after yesterday’s surge, ABG’s shares are trading on a current-year earnings multiple of 12 times, falling to 8.7 next year. Other sector players trade on even lower multiples.

This move by China may or may not mark the start of a wave M&A in gold miners. However, the sector certainly looks ripe for consolidation for companies with the financial muscle to buy quality assets.

Questor last said ABG shares were a speculative buy on July 24 when they stood at 317p. They are now 34pc above that level. Because the bid situation is unclear, the rating is now cut to hold.