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.

Revenue Mix

Business                                                            Geography

Investment Rationale

• Acquisition of Detour Gold Corporation to Benefit in the Long-run: 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 US$ 628 and AISC per ounce sold of US$ 1,098. For the same period, revenue from Detour Lake totalled US$ 412.4 million and earnings from operations were US$ 135.5 million. The mine generated US$ 167.0 million of free cash flow.

• Lower Balance Sheet Risk: Debt/Equity Ratio of the company stood at 0.01%, which reflects neglible 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.

2QFY20 Comparison, Source: Refinitiv (Thomson Reuters, Kalkine Group)

• Solid Q2FY20 Performance: The group’s reported revenue doubled in the quarter on a YoY basis to US$ 581.0 million, driven by 30% surge in the average realised gold prices 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.

2QFY20 Comparison, Source: Refinitiv (Thomson Reuters, Kalkine Group)

• Higher Gold Prices Would Continue to Benefit Financial Performance: Yellow metal prices tested a record high price of US$2,077/oz in August 2020. However, it gave up some of the gains since then; but still up approximately 7% from the second quarter closing price of US$ 1,822.40/oz. In the second quarter of the financial year 2020, KL’s average gold price was US$ 1,716/oz, 8.2% higher against the Q1FY20 average gold realised price of US$ 1,586/oz. We believe that despite a recent pullback in the gold price the average gold realisation price for the KL in the Q3FY20 would surge between 5%-6% on a sequential-quarter basis, which would further enhance margin and profitability in the third quarter of FY20.

• Lower Oil Prices would contribute to Margin Expansion: Higher gold prices are not the only factor which is going to help in the margin expansion. Gold miners are likely to benefit from lower oil prices as well. The mining and processing of gold require the consumption of energy and thus oil, as diesel gas 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.

• Strong Competitive Advantage: Kirkland’s LTM Return on Capital Employed (ROCE) stood at 25.9%, and Weighted Average Cost of Capital (WACC) stood at 8.6%, which implies a positive spread of 17 percentage points. This reflects a strong competitive advantage of the company in terms of funds deployment at significantly highly profitable projects. This also reflects that the company is in the hand of efficient management.

Source: Kalkine Group, Refinitiv (Thomson Reuters)

• Relative Price Strength: Shares of KL have significantly outperformed the benchmark index amid this challenging time. In a year over period, its shares outperformed the benchmark TSX Composite by 11.56% and by 16% on a YTD basis. 

Relative Price Performance (KL vs TSX Composite, as on October 21, 2020). Source: Refinitiv (Thomson Reuters)

• Risk Associated to Investment: Performance of the Kirkland’s stock is highly exposed to the volatility in the gold prices, a sharp pull-back in the gold prices in the wake of recovery in the broader economy could weigh on the KL’s stocks. Further, the company is also exposed to crude oil prices, currency exchange and interest rate risks.

Gold Industry Outlook

Gold skeptics have raised questions on the tepid demand of gold jewellery but overlooking the fact that it is substituted by increasing demand of coins and ETFs as a proxy. Gold ETFs are currently holding 3,800 tonnes of gold, a rise of 21% and as the momentum picks up, more money flows into this asset class. One of the key facts often missed is that gold shines as well as sparkles in a real negative interest rate scenario when the cost of carrying and financing is nil and dollar and T bills are not giving any real yield. We believe that gold would continue to remain in the investor’s limelight as a lot of uncertainties hovering over the global economic recovery and stability in the capital market instruments.

KL’s 2QFY20 Highlights (fig. in US $)

Source: Company Presentation

• Revenue in Q2 2020 totalled US$ 581.0 million, an increase of US$ 299.7 million, or 107% from Q2 2019, with Detour Lake contributing US$ 233.0 million to the Company's revenue for the quarter.
• Net cash provided by operating activities in Q2 2020 totalled US$ 222.2 million with free cash flow totalling to US$ 94.1 million.
• Net earnings in Q2 2020 totalled US$ 150.2 million or US$ 0.54 per share as compared to US$ 104.2 million or US$ 0.50 per share in Q2 2019.
• During the quarter under consideration, the group’s total exploration expenditures totalled US$ 25.0 million, including US$ 2.4 million of expensed expenditures and US$ 22.6 million of capitalized expenditures.
• The board has declared a quarterly dividend of US$ 0.125 per share for the second quarter of the financial year 2020.

Source: Company Presentation

• During Q2FY20, the company has reported solid growth in adjusted earnings despite COVID-19 outbreak. Adjusted Free Cash Flow recorded a growth of 92% on YTD basis.
• Consolidated Q2 2020 production totalled 329,770 ounces, a 54% increase from 214,593 ounces in Q2 2019. The main contributor to the strong growth compared to the same period in 2019 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. The reduction was 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.
• Production costs in Q2 2020 came in at US$ 141.4 million versus US$ 66.2 million in Q2 2019. The increase from Q2 2019 largely reflected the inclusion of US$ 85.8 million of production costs from Detour Lake in Q2 2020. Operating cash costs per ounce sold averaged US$ 374 in Q2 2020 compared to US$ 312 in Q2 2019. The change from Q2 2019 related to the inclusion of Detour Lake in Q2 2020, where operating cash costs per ounce sold averaged US$ 573.
• All-in sustaining costs (“AISC”) per ounce sold averaged US$ 751 in Q2 2020 compared to US$ 638 in Q2 2019. The inclusion of Detour Lake Mine, where AISC per ounce sold averaged US$ 1,090, contributed to the increase from Q2 2019

Price Performance

Source: Refinitiv (Thomson Reuters), Chart represent daily closing price

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

Note: All forecasted figures have been taken from Thomson Reuters

Stock Recommendation: The company has a strong fundamental with a robust balance sheet, with a cash balance of US$ 537.4 million at June 30, 2020, with virtually zero debt, a solid operating platform in leading mining jurisdictions, high-quality projects with significant exploration upside and a strong leadership team committed to achieving goals, creating shareholder value and maintaining a responsible and sustainable mining business.

The group has reported strong financial performance in the second quarter of the financial 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 revenue, profit, free cash flow and bringing down All-in sustaining costs ("AISC") per ounce sold.

Further, we are bullish on the gold prices and believe despite little pull-backs 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 edge higher day by day, we expect that flow in gold ETFs would continue to be strong, and it will continue to send yellow metal prices higher. Consequently, the average realised gold prices per ounce would expand, which would lead to a margin expansion and higher free cash flow for the company.

Therefore, based on the above rationale and valuation, we have given a "Buy" recommendation at the closing price of CAD 63.19 on October 21, 2020. 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 October 22, 2020 price as well.

Disclaimer

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