It's been a rough start to June for the Gold Miners Index (GDX), and many names have slid more than 20% from their highs. These violent corrections in the sector can present great buying opportunities if one focuses on the best names that offer exceptional value and a proven track record of success. Kirkland Lake Gold (KL) is one name that fits this mold and is now back on the sale rack, sitting more than 33% off its Q32 2020 highs. Given the stock's deeply discounted valuation, despite being the only Tier-1 producer with sub $850/oz costs, I see this sharp correction below $38.80 as a low-risk buying opportunity.
(Source: Company Presentation)
Kirkland Lake Gold released its Q1 results in May and reported quarterly gold production of ~302,800 ounces, an 8% beat on the production guidance mid-point of 280,000 ounces. Despite a stronger Canadian Dollar than guided for where Kirkland Lake produces more than 60% of its gold, the company easily beat its cost guidance of $1,000/oz for Q1, with costs coming in 15% lower than expected at $846/oz. Some investors might be unnerved by the lower production year-over-year and lower revenue, a deviation from the sector norm due to higher gold (GLD) prices. However, it's important to note that Kirkland Lake was up against a significant headwind with its Holt Mine no longer in production (Q1 2020: ~28,600 ounces). Let's take a closer look at the quarter below:
(Source: Company Filings, Author's Chart)
As shown above, production was down at three of Kirkland Lake's mines in Q1, with Macassa, Fosterville, and Holt all seeing lower production, with the latter due to being placed on care & maintenance. This was offset by a massive beat at Detour Lake, with production up more than 60% year-over-year to ~146,700 ounces, benefiting from a full quarter of production following the acquisition. As discussed earlier, this is by far Kirkland Lake's weakest quarter of the year, so extrapolating the ~302,800 ounces over the year would be a significant mistake. In fact, the company is on track to beat the high-end of its guidance of 1.35 million ounces, with the potential for ~660,000 ounces in H1 2021, and 750,000 ounces in H2 2021 as we see better grades in H2.
One significant positive development worth mentioning for Kirkland Lake is that COVID-19 should no longer be nearly as much of a headwind, with Ontario vaccination rates soaring since Q1 2021. As of this week, nearly 70% of Ontarians have received at least one dose, and case counts have dropped from a peak of 4,400 per day on April 16th to less than 400 currently. This significantly de-risks Kirkland Lake's 2021 production estimates, given that roughly 70% of production was set to come from its Ontario operations (Macassa and Detour Lake).
(Source: Company Presentation)
Many investors continue to assume that Kirkland Lake's best days are over, with the perception being that Detour Lake is a massive high-cost mine that will pull up costs. However, the Detour Lake of today is nothing like that of the future, and investors should not be focused on the five years of operations before the mine was acquired or the most recent quarterly results, which are a country mile away from the mine's true potential. This is because FY2021-FY2025 production is expected to average ~724,000 ounces at $775/oz, a significant improvement from ~567,000 ounces in FY2015-FY2019 at $1,080/oz.
Assuming successful execution, this will bring Detour's costs 23% below the industry average vs. 4% above currently and make Detour Lake one of the largest gold mines globally. With a high likelihood of net additions in reserves with the company's aggressive drill program and the addition of the new Saddle Zone, it's looking like Detour Lake should be able to produce well into 2050 when we factor in resource conversion from the ~5.2 million-ounce resource base that's separate from reserves. I would argue that this makes Detour Lake one of the top-10 assets in the sector currently. This is a testament to management's impressive foresight to pick up the asset for just ~$3.7 billion or less than 0.90x NPV (5%). Based on the most recent estimates, the Detour is expected to generate ~$6.38 billion in after-tax free-cash-flow even at just a $1,500/oz gold price.
(Source: Company Filings, Author's Chart)
If we look further ahead, the mine is expected to get even better into the 2030s, with production averaging ~888,000 ounces between FY2031 and FY2036. Shorter-term, Kirkland Lake's goal is to maximize production and get to the FY2025 target of 800,000 ounces as quickly as possible while also filling in the gap between FY2027 and FY2030, where production dips considerably. The company has noted that it is looking at optimizing slope angles in the North wall, improving grade control, and exploration potential from the Saddle Zone, with the hopes of filling in this gap. We could see an update to this in the FY2022 Mine Plan, given that we will see the benefits of business improvements, the addition of Saddle, and an overall larger reserve base in the 2022 Life of Mine Plan [LOMP].
(Source: Company Presentation)
So, how does the valuation look?
Despite Kirkland Lake Gold being the only gold producer in the sector with all of its mines in Tier-1 jurisdictions and a cost profile below $850/oz, the company continues to trade at a discount to many of its senior producer peers with inferior margins and inferior jurisdictions. As shown below, Kirkland Lake is currently valued at less than $475/oz based on ~20.1 million ounces of gold reserves vs. Agnico Eagle (NYSE:AEM) at $696/oz with ~24.1 million ounces of gold reserves. Not only does Kirkland Lake Gold have significantly better costs than Agnico Eagle, but it also has a superior jurisdiction profile. This is because 100% of Kirkland Lake's gold production has come from Tier-1 jurisdictions on a trailing-twelve-month basis, a 1200-basis point increase vs. 88% for Agnico Eagle.
(Source: Company Filings, Author's Chart)
Before the acquisition of Detour Lake and the decision to right-size Fosterville, Kirkland Lake Gold traded at a premium to Agnico Eagle on a valuation per ounce basis and a similar earnings multiple of 20. Assuming Kirkland Lake were to close some of this gap and trade at a valuation of $600.00 per reserve ounce, Kirkland Lake's valuation would increase to $13.2 billion, or more than $52.40 per share. On an earnings multiple basis, even if Kirkland Lake closed just half of the gap with Agnico Eagle and traded at an earnings multiple of 16, the stock would trade at a share price of $59.20. The latter calculation assumes FY2022 annual EPS estimates of $3.70.
(Source: Company Filings, Author's Chart)
Obviously, there's no reason that the market has to re-price Kirkland Lake Gold, but the best opportunities come when a stock is significantly undervalued, even when baking in conservative estimates. If we look at the chart above, Kirkland Lake Gold looks even more undervalued relative to its peers, with the company's valuation per ounce dropping to under ~$420.00/oz based on a higher cash balance of $1.2 billion and a reserve base of ~22.0 million ounces. This assumes the cash balance increases by $450 million during FY2021, which I believe is conservative even after factoring in potential buybacks, and the reserve base grows by 1.9 million ounces year-over-year.
(Source: Company Presentation)
Given that we've yet to see any of Kirkland Lake's drilling success added to the Detour Lake reserve base, I believe an upgrade to a ~22.0 million-ounce reserve base should be achievable. As of year-end, Kirkland Lake will have drilled over 335,000 meters at Detour Lake (FY2020: ~70,000 meters, FY2021: ~270,000 meters). To date, this drilling has been enormously successful, with a new zone defined above (Saddle Zone) and multiple impressive intercepts drilled below the current pit. A few highlight holes include 13.0 meters of 10.66 grams per tonne gold and 51.9 meters of 2.94 grams per tonne gold at the future West Pit and west of the West Pit, 35.1 meters of 2.54 grams per tonne gold from the Main Pit, and 31.91 meters of 5.0 grams per tonne gold and 64 meters of 1.96 grams per tonne gold at the Saddle Zone.
While the majority of the focus by investors has been on Detour and Fosterville, it's worth noting that the company's smallest asset is set to be transformed in FY2022, with the #4 Shaft Project that remains ahead of schedule and on budget. While production is guided for 238,000 ounces in FY2021 at the mid-point, Macassa's production is expected to soar to ~310,000 ounces in FY2022 before increasing to ~412,000 ounces in FY2023. So, while Fosterville's costs are increasing due to a lower production profile while the company hunts down new reserves, Macassa is expected to become one of the largest and lowest-cost underground mines globally.
(Source: Company Presentation)
Assuming the company meets its production targets, we should see all-in sustaining costs dip below $600/oz, translating to a more than $300/oz increase in all-in sustaining cost margins assuming a flat gold price. Most importantly, the new shaft will allow for triple the ventilation and allow the company to explore this extremely high-grade asset more effectively. So, between $90 million in drilling & development at Fosterville, a 270,000-meter drill program at Detour Lake, and a material ramp-up in production beginning next year at Macassa, several positive catalysts on the horizon should help the stock to achieve a re-rating more in line with historical levels.
At a current share price of $38.70, Kirkland Lake is sitting at an enterprise value of barely ~$8.4 billion, with the potential to generate more than $7.0 billion in after-tax free cash flow from Detour alone at a $1,550/oz gold price. This suggests that the company isn’t getting anywhere near fair value for its two high-grade Tier-1 assets (Macassa & Fosterville). Based on this, the current pullback looks like a low-risk entry for long-term investors, with the potential for a re-rating to over $55.00 per share based on what I believe to be a conservative earnings multiple of 15. At a multiple more in line with Agnico Eagle, fair value would increase to more than $64.00 per share. With the company also paying a nearly 2.0% yield, having significant room to increase its dividend, and having enough cash on hand to buy back over 8% of its float, I continue to see Kirkland Lake as one of the best reward/risk propositions in the sector.