Kirkland Lake Gold (TSX: KL) is a leading gold producer with several wholly-owned operating mines in Canada and Australia. In 2019, the company produced 974,615 oz gold led by two of its high-grade, low-cost underground mining operations namely the Macassa mine in Canada and the Fosterville mine located in Australia. Further, in January 2020, the company announced that it had completed the acquisition of Detour Gold.

Investment Rationale

• Strong Financial Performance in the second quarter of 2020: The group reported a solid performance during the quarter on the back of soaring gold prices and higher demand for the yellow metal. The group’s revenue rose ~107% to US$ 581.0 million. The growth in revenue was driven by a 30% surge in the average realized gold prices on a YoY basis and 61% upsurge in the gold sales volume at 341,390 ounces. Further, EBITDA leapt up by 67% (YoY), with a strong free cash flow of US$ 94.1 million as Detour Lake generated $89.0 million of free cash flow in Q2 2020.

• Record high gold prices would continue to drive performance: Yellow metal prices tested a record high of US$2,077/oz on 7 August 2020, however, gave up some of the gains in the past few trading sessions. But prices are still up approximately 7% from the second quarter closing price of US$ 1,822.40/oz. In the second quarter of FY20, KL’s average realized gold price stood at US$ 1,716/oz, 8.2% higher against the Q1FY20 average gold realized price of US$ 1,586/oz. We believe that despite a recent pullback in the gold price the average gold realization price for the KL in the Q3FY20 would surge, which indicates a further expansion of margin and profitability, and also a higher free cash flow generation for the company.

• Margin Expansion from Lower Oil Prices: The higher gold price is not the only factor that is driving the margin of the gold miners. They are also benefiting from the lower oil prices. The mining and processing of gold require the consumption of energy and oil is needed to operate heavy machinery and vehicles to transport gold ore. This is especially true with open-pit mines, where a haul truck or dump truck is required.

• No Balance Sheet Risk: The group has virtually zero debt in its balance sheet and debt to equity ratio stood at 0.01%, which suggests no balance sheet risk for the company. Also, it implies that the majority of the group’s capex funding comes from the internal cash flow generation. Also, a lower debt contribution leads to higher Return Capital Employed and higher free cash flow generation.

• Free Cash Flow Yield of 4.9% implies a greater margin of safety: Free cash flow yield is a valuable metric, especially from an investor standpoint. It acts as an indicator of the financial health of the company and indicates how efficiently a company is running its operations. In essence, it is a solid indicator of how financially stable a company is.

• Strong Competitive Advantage: Kirkland’s LTM Return on Capital Employed (ROCE) stood at 25.9%, according to the data compiled from Refinitiv and Weighted Average Cost of Capital (WACC) stood at 8.6%, which implies a positive spread of 17% between ROCE and WACC. The company has leading ROCE among its peers, and higher ROCE and WACC spread among the close peers.

Source: Refinitiv (Thomson Reuters)

• Relative Price Strength: Shares of KL have significantly outperformed the benchmark indices amid this challenging time and outperformed its sector peers in the past 3-Month and 1-Month time frame. In the last three months, its shares have surged approximately 16% and outperformed the benchmark index by ~4% and sector peers by ~11% at the same time. Further, its shares are featuring a positive price return of 13% and 6% on a YTD and YoY basis and outperforming the benchmark index at the same time. These price performances reflect a strong relative strength in the index over the above described periods.

• Detour Gold Corporation- a third cornerstone asset to the company’s portfolio: On January 31, 2020, the company acquired all issued and outstanding shares of Detour Gold Corporation. The acquisition adds a third cornerstone asset to the company’s portfolio, with 2019 production at Detour Lake of 601,566 ounces. Like Macassa and Fosterville, Detour Lake combines free cash-generating operations with significant in-mine growth potential and attractive regional exploration upside. From January 31, 2020, to the end of Q2 2020, Detour Lake produced 223,547 ounces of gold, with gold sales totalling 246,638 ounces, operating cash costs per ounce of $628 and AISC per ounce sold of $1,098. For the same period, revenue from Detour Lake totalled $412.4 million, earnings from operations were $135.5 million and the mine generated $167.0 million of free cash flow.

• Risk Associated to Investment: Kirkland Lake Gold’s financial performance is closely tied to the prices of gold. The prices of gold are subject to volatility and can be affected by multiple macroeconomic factors. Further, mining activities involve a high degree of risks stemming from unexpected geological formations. Further, the company is also exposed to crude oil prices, currency exchange and interest rate risks. 

Gold Industry Outlook

Gold prices have recorded a little correction over the past few trading sessions but inched on Wednesday and ended higher against the previous trading session, reaching towards the 50-day EMA. However, the recent correction was mainly because of global stimulus measures to support a battered economy, negative real rates and a weaker dollar. The yellow metal had surged more than 30% this year, surpassing the previous all-time high set in 2011. The rally, one of the best among commodities and expected to continue the pace for the next few quarters. Gold’s decline this week is also likely due to technical selling and profit-taking. The 14-day relative-strength index had held above 70 for the past three weeks, a warning to some chart watchers that the market had become too hot. There were plenty of calls for prices to climb higher before the recent decline. Some industry experts are predicting gold prices to touch US$3,000, which suggest that correction does not signal the end of gold’s run.

Further, gold-backed ETFs have witnessed record inflows so far in 2020 as the coronavirus pandemic and geopolitical tensions are creating demand for safe-haven assets like gold. Going by new data released by World Gold Council, gold-backed ETFs witnessed the eighth consecutive month of positive flows in July and added 166 tonnes equivalent to around $9.7 billion or 4.1% of assets under management. Notably, global AUM in gold ETFs was $239 billion at the end of July, according to the report. Contribution in around 75% of global net inflows in July came from North American funds which added $7.0 billion or 5.5% of AUM.

KL’s 2QFY20 Highlights (fig. in US$)

During the Q2FY20, the company has reported Solid Growth in Adjusted Earnings Despite COVID-19, and YTD Adjusted Free Cash Flow grew 92%.

Source: Company Presentation

Consolidated Q2 2020 production totalled 329,770 ounces, a 54% increase from 214,593 ounces in Q2 2019 and largely unchanged from 330,864 ounces the previous quarter. The main contributor to the strong growth was 131,992 ounces of production from Detour Lake. Production at Fosterville totalled 155,106 ounces in Q2 2020, a 10% increase from the same period in 2019 largely due to higher tonnes processed. Macassa produced 41,865 ounces in Q2 2020 versus 49,196 ounces in Q2 2019 and 50,861 ounces the previous quarter. The reductions were mainly reflecting the impact of COVID-19 protocols on tonnes processed as well as a lower average grade during Q2 2020. At Holt Complex, operations were suspended effective April 2, 2020. As a result, the operations produced only 807 ounces in Q2 2020, which compared to 24,696 ounces for the same period in 2019 and 28,584 ounces in Q1 2020.

Production costs in Q2 2020 totalled $141.4 million versus $66.2 million in Q2 2019 and $161.6 million in the previous quarter. The increase from Q2 2019 largely reflected the inclusion of $85.8 million of production costs from Detour Lake in Q2 2020. Operating cash costs per ounce sold averaged $374 in Q2 2020 compared to $312 in Q2 2019 and $440 in Q1 2020. The change from Q2 2019 reflects the inclusion of Detour Lake in Q2 2020, where operating cash costs per ounce sold averaged at $573.

All-in sustaining costs (“AISC”) per ounce sold averaged $751 in Q2 2020 compared to $638 in Q2 2019 and $776 the previous quarter. The inclusion of Detour Lake Mine, where AISC per ounce sold averaged $1,090, contributed to the increase from Q2 2019.

Source: Company Presentation

Revenue in Q2 2020 totalled $581.0 million, an increase of $299.7 million, or 107% from Q2 2019, with Detour Lake contributing $233.0 million to the Company's revenue for the quarter.

Net cash provided by operating activities in Q2 2020 totalled $222.2 million with free cash flow totalling to $94.1 million. Both net cash provided by operating activities and free cash flow was impacted by a $132.6 million tax payment made in Australia as the final tax instalment for the 2019 tax year in the second quarter. Excluding the impact of the $132.6 million tax payment, net cash provided by operating activities and free cash flow for Q2 2020 totalled $354.8 million and $226.7 million, respectively. Detour Lake Mine contributed $89.0 million to the Company's free cash flow in Q2 2020.

Net earnings in Q2 2020 totalled $150.2 million or $0.54 per share as compared to $104.2 million or $0.50 per share in Q2 2019 and $202.9 million or $0.79 per share in the previous quarter.

The board has declared a quarterly dividend of US$ 0.125 per share for the second quarter of the financial year 2020, which was paid on July 13, 2020 to shareholders of record on June 30, 2020.

Stock Performance

At the closing (on August 12, 2020), shares of KL traded 0.69% higher against the previous trading session at CAD 64.47. Over the last year, its shares have tested a 52W high price of CAD 76.43 on August 5, 2020 and a 52W low price of CAD 25.67 on March 16, 2020. At the last closing price, KL shares have traded approximately 15.65% below from its 52W high price level and traded approximately 151% above from its 52W low price level. This reflects that the stock is tilted towards its 52W High price level, a positive price trend.

Further, its shares are featuring a positive price return on a YoY, YTD, 3-Month and 1-month basis and up by approximately 6%, 13%, 16% and 3.5% respectively.

Moreover, its shares are hovering in a strong uptrend, as traded well above its crucial short-term and long-term moving averages of 200-day, 100-day, 50-day and 30-day SMAs. Further, MACD is rising, and the difference between short-length 12-day and slow-length 26-day EMA positive, a bullish price signal.

Valuation Methodology (Illustrative): Price to Cash Flow based Valuation Metrics

Note: All forecasted figures have been taken from Thomson Reuters

Stock Recommendation: The group has reported strong financial performance in the second quarter of the fiscal year 2020. Further, the acquisition of Detour Gold Corporation adds a third cornerstone asset to the company's portfolio, with a strong contribution in the group's total revenue, profit, free cash flow and bringing down All-in sustaining costs ("AISC") per ounce sold.

The company has a strong fundamental with a robust balance sheet, with a cash balance of $537.4 million at June 30, 2020, with no debt. The group has a solid operating platform in leading mining jurisdictions with high-quality projects and significant exploration upside.

Further, we are bullish on the gold prices and believe that despite a little pull-back, gold as an asset class would continue to remain in the limelight as uncertainty over the global economic growth has heightened, with economies across the globe witnessing very slow recovery rate and COVID-19 cases continue to edging higher day by day. Further, ETFs are showing no sign of decline in gold buying, which is likely to send yellow metal prices higher. As the gold prices are likely to remain elevated, we believe that average realised gold prices per ounce would continue to expand, which would lead to margin expansion, higher free cash flow for the company.

Therefore, based on the above rationale and valuation done using the above methodology, we have given a "Buy" recommendation at the closing price of CAD 64.47 (as on August 12, 2020), with a lower double-digit upside potential, based on the NTM Peer's Average Price to Cash Flow Per Share multiple of 12.80x, on the FY20E Cash Flow Per Share. We have considered B2Gold Corp, Kinross Gold Corp and Agnico Eagle Mines Ltd etc., as a peer group for the comparison purpose.

*Recommendation is valid at August 13, 2020 price as well.

Disclaimer

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