Barrick to shutter Lumwana as Zambian gov’t hikes royalty

Barrick Gold (TSX: ABX; NYSE: ABX) will soon suspend operations at its Lumwana copper mine in Zambia in response to the Zambian government’s move to more than triple the royalty rate on open-pit mines, starting in 2015.

The Zambian government recently approved a new tax regime, which replaces the current 29% corporate tax, 15% variable tax and 6% royalty rate for open-pit mining, with a 20% gross royalty on revenue. 

The large gold producer previously warned investors that if this happens, it would place its marginal Lumwana copper mine on care and maintenance come Jan. 1.

“Despite the progress we have made to reduce costs and improve efficiency at the mine, the economics of an operation such as Lumwana cannot support a 20% gross royalty, particularly in the current copper price environment,” Barrick co-president Kelvin Dushnisky said.

Andy Lloyd, Barrick’s vice-president of communications, said that under the new tax regime, payments would be “substantially higher” than the US$81 million Barrick paid in taxes and royalties in Zambia last year. He added that Barrick would lose deductions for capital investments with the removal of the income tax. 

As part of the ramp-down, Barrick intends to start major workforce reductions in March 2015, jeopardizing the mine’s 4,000 employee and contractor jobs. The company expects to conclude the transition to care and maintenance by June. The move will also hurt Zambian suppliers that sold US$400 million of goods and services to Barrick last year. 

 It is unclear whether the Zambian government will reconsider its tax regime to prevent the shutdown and resulting loss of jobs and businesses. If the government doesn’t amend its royalty decision, Barrick expects to take an impairment charge on Lumwana in the fourth quarter of 2014. The mine’s current carrying value is US$1 billion.

This wouldn’t be the first writedown for the mine. Last year Barrick took a US$3.8-billion after-tax charge on the operation and its copper business, partly due to higher operating and sustaining costs and lower copper prices. The miner was also criticized for overpaying for Lumwana via its $7.3-billion acquisition of Equinox Minerals in 2011.  

BMO Nesbitt Burns analyst David Haughton notes that by incorporating the 20% mining royalty, Lumwana’s net present value drops by 75% to US$240 million.

 Given the planned suspension, Haughton has revised his 2015 earnings-per-share estimate for Barrick to US55¢ per share from US60¢. He has lowered his US$17 price target to US$14, and rates the stock as “market perform.”

Raymond James analyst Phil Russo forecasts the tax change would increase the mine’s 2015 C3 costs to over US$3 per lb., which is above the current spot price of US$2.85 per lb. “Given the mine’s year-to-date cost profile of C3 cash costs of US$2.98 per lb., the mine has little room to carry the proposed royalty regime,” he writes. Russo has removed the mine from his valuation and has cut his US$17 target to US$14.50 per share. He rates Barrick as “market perform 3.” 

Similarly, Canaccord Genuity analyst Tony Lesiak has eliminated Lumwana from his estimates. He warns that Barrick will have trouble building new mines with its $12.9-billion debt load and that suspending Lumwana “exacerbates the situation.” He has slashed his target to $11.50 from $17.50, and downgraded the stock to “sell” from “hold.” 

For the nine months ended in September, Lumwana produced 138 million lb. at C3 fully allocated costs of US$2.98 per lb. While production dropped from the same period last year, costs have slightly improved.

Given the pending suspension, Bank of America Merrill Lynch analyst Michael Jalonen has reduced his 2015 copper forecast for Lumwana by 74% to 67 million lb. This lowers his company-wide 2015 copper production forecast by 38% to 305 million lb. Jalonen has cut Barrick’s price objective to US$14.50 from US$16.50 per share.Barrick ended Dec. 18 at $12.85, 46% off its 52-week high of $23.78 reached in February.