Kirkland Lake Gold's South Mine Complex Will Propel Shares

| About: Kirkland Lake (KL)
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Summary

Kirkland Lake Gold's Macassa Mine has some of the highest reserve grades in the world.

The South Mine Complex at Macassa will result in greatly improved operating cash flow over the next several years.

The near surface ore at the South Claims could be a game changer.

None of this future cash flow is being priced into the stock yet, as it might be another 1-2 years before real and dramatic results are seen.

If you are a long-term investor, then I would strongly suggest that you take a look at Kirkland Lake Gold (OTCPK:KGILF), as the company's South Mine Complex at its Macassa Mine should eventually propel shares much higher. It might not happen overnight, but in 1-2 years the stock price should be 100% higher, and that is in a flat gold price environment. Before we get more into the "Why", let's first just talk a little about the company's Macassa Mine.

Macassa is a past producing operation in the Lower Abitibi Greenstone belt in Kirkland Lake, Ontario, and it was formerly owned and operated by Kinross Gold (KGC) until it was shut down in 1999.

Kirkland Lake recommenced production at Macassa in 2005 and launched a major exploration program that resulted in the discovery of the high-grade South Mine Complex (SMC). This has allowed the company to expand production over the last several years.

Macassa has a total reserve base of almost 1.4 million ounces of gold grading 17.10 g/t, which is among the top reserve grades in the world.

(Source: Kirkland Lake Gold)

The company also has an additional 2 million ounces of gold in M&I resources. All together the company has a resources base of 4.5 million ounces at an extremely high grade. I would like to add that these ounces are all located in one of the best mining jurisdictions in the world.

As of December 31, 2013)

TONS

GRADE (opt)

GRADE(gpt)

OUNCES

Proven and Probable

2,784,000

0.50

17.1

1,385,000

Measured and Indicated

4,152,000

0.49

16.8

2,055,000

Inferred

2,092,000

0.54

18.5

1,133,000

The "Why"

As I mentioned, it's the South Mine Complex that will eventually take shares of Kirkland Lake Gold to the next level as this story is just going to keep getting better and better. The graph below of the high-grade South Mine Complex shows why this is.

A large portion of production from Macassa comes from the South Mine Complex that exist within the overall Macassa complex. The company was mining on the 5025 level and the 5300 level of this SMC zone. The reserve grade of those two blocks is about .46 oz per ton. However, look what happens as the SMC goes deeper. The grade dramatically increases. It's .57 oz/ton on the 5400 level, .70 oz/ton on the 5600 level, and a whopping .91 oz/ton on the 57-66 level. The 57-66 level contains 703,000 ounces of Measured and Indicated resources and is open at depth and along strike.

(Source: Kirkland Lake Gold)

This is what excites me the most about this company, this is why the shares have so much upside. The fact is they will be doubling the production grade at the SMC over the next few years. And I might add that there are only incremental increases in costs as they move down to the lower levels.

Kirkland Lake seems to be developing these levels aggressively, as they are already on the 5400 level and by this time next year they should be on the 5600 level where the reserve grade is .70 oz per ton. Once they reach the 5600 level they can start to drill off those 700,000 ounces below. And at .90 oz per ton that is 3 1/2 years of production at an extremely high grade.

As I mentioned, the majority of production at Macassa comes from the SMC, the rest comes from the Main Break. That high-grade ore from the SMC will dramatically boost profitability over the next several years.

(Source: Kirkland Lake Gold)

The company will be spinning off a ton of cash flow in about 1-2 years even if gold remains at $1,200 per ounce.

Below is what Kirkland Lake Gold is projecting in terms of production for the next 3 years. Let me also note that their fiscal year begins in May, so right now they are in the third quarter of FY2015.

Production Guidance

FY2015

140,000 - 155,000 ounces

FY2016

150,000 - 170,000 ounces

FY2017

160,000 - 180,000 ounces

The company is on track to meet its FY2015 production target, and FY2016-2017 are forecast to increase. However, I think these figures are very conservative as the production profile grades that Kirkland Lake Gold is estimating aren't reserve grades, but rather they are what the company has been mining in previous years. In other words the company is assuming that during FY2015, they will be mining grades at .37 oz/ton. If they hit the reserve grade then FY2015 production will be at .44 oz per ton. As I mentioned earlier, during June and July the company was mining at the reserve grade, so it's very likely that the company will greatly exceed .37 oz/ton. More ounces per ton means more production.

In FY2016 and FY2017 the grades are expected to be .39 g/t and .41 g/t respectively. If they mine at the reserve grade then 2016 would be .46 oz per ton, and 2017 would be .48 oz per ton.

In other words, Kirkland Lake Gold's estimated production guidance for the next few years is probably way too low. It comes down to simple math. The company will be mining at 1,150-1,250 tons per day, figure a few weeks of shutdown time each year for maintenance:

  • 1,200 tons per day x mined grade x 351 days

Let's look at two scenarios here, one mining at the estimated grade and one at the reserve grade.

Estimated Grade Production Reserve Grade Production
FY2016 164,268 ounces 193,752 ounces
FY2017 172,692 ounces 202,176 ounces

That increase in grade results in 30,000 ounces of additional production in FY2016 and FY2017. That's $36 million more per year in operating cash flow at $1,200 gold. Even if they manage to mine in between the estimated grade and reserve grade, that is still an additional $18 million of cash flow per year.

The bottom line is that once Kirkland Lake Gold reaches the lower levels at SMC, the company's cash cost is going to plummet and free cash flow should increase dramatically. It will take another year or so to reach the higher grade, so don't expect the shares to skyrocket right now. But everything is in place for this to happen; all the company needs to do is continue to execute.

A Possible Game Changer At Macassa

I have talked about how the South Mine Complex will dramatically boost profits at Macassa. However, there is another factor at Macassa that could be a complete game changer.

Kirkland Lake Gold has a 2,200 ton per day mill which they invested $35 million in during their expansion. So given that the company only plans to be mining about 1,200 tpd, that means they have about 1,000 tons of excess capacity.

Kirkland had a 50/50 JV with Queenston Mining on what is known as the South Claims. In 2012, Kirkland Lake paid $60 million for Queenston's 50% share, giving Kirkland 100% ownership of the property. Kirkland Lake Gold wasn't really drilling the South Claims until they took full ownership. After the purchase was completed they started drilling, and have been for the last 15 months or so. The company discovered near surface mineralization from 100 ft below the surface, extending down to 1000 ft.. It's not cut off at depth but there is no point in drilling down further yet.

In April of 2014 the company put out its first resource on that near surface mineralization, with 104,000 oz of M&I resources at 0.34 opt (11.7 gpt) and 48,000 oz of Inferred resources at 0.36 opt (12.3gpt). That's 152,000 oz of near surface gold that is extremely high in grade.

The distance from the mill to this near surface mineralization is only 1.5 km. These resources could be accessible via a decline with the ore being trucked to the mill as supplemental feed.

(Source: Kirkland Lake Gold)

Because it's so close to the surface, the company expects the mining costs to be only $150 per ton; compare that to Macassa at 5000 ft down and $300-$350 per ton. This new discovery could be a game changer in the next 2-3 years. The ore is at such a shallow depth and it so high in grade that the cash costs at Macassa would be some of the lowest in the industry once Kirkland Lake reaches the lower part of the SMC and if they start using this high grade supplemental feed from the South Claims. However, the company doesn't need for the South Claims to come online to be successful.

The Valuation

As I mentioned earlier the current reserves at Macassa are about 1.4 million ounces at a half ounce per ton, which equates to a 7 year mine life at 200,000 ounces per year. There are an additional 2 million ounces in Measured and Indicated resources. The company believes that it can convert 70% of those resources into reserves, so that's another 1.4 million ounces. That's 2.8 million ounces of gold, which equates to a 14 year mine life at 200,000 ounces of production per year.

I think using a 14 year mine-life at 175,000 ounces per year would be conservative in my valuation analysis. Especially considering the company's recent exploration success at the South Claims and the fact that the South Mine Complex is open at depth and along strike.

The all-in sustaining cash costs averaged US$900 in June and July. While the company expects that all-in costs will be higher than that for the remainder of the year, given the increased grade that will be mined from here on out, all-in cash costs should be at US$900 per ounce or less on average for the remaining LOM. I will use a US$1,000 all-in costs for my valuation. According to the company's latest annual report:

The mine life is currently estimated at approximately 14 years. The payback period of capital is currently estimated to be approximately six years.

So I'm going to assume the next 6 years of production will be tax free at $1,250 gold. According to the company, their combined tax rate is 27.5%. Also, in October 2013, Kirkland Lake Gold announced that Franco-Nevada purchased a 2.5% NSR royalty on Macassa for US$50 million. Kirkland Lake does have a 3 year option to buy back 1% of the NSR, but it will cost them US$36 million. So I will assume a 1.5% royalty as well. Using a 5% discount rate, the Macassa Mine has the following valuation:

Base Case

NPV(5%) = $387,884,534.44

Period Cash Flow Present Value
0 43,093,750.00 43,093,750.00
1 43,093,750.00 41,041,666.67
2 43,093,750.00 39,087,301.59
3 43,093,750.00 37,226,001.51
4 43,093,750.00 35,453,334.77
5 43,093,750.00 33,765,080.74
6 31,242,968.00 23,313,983.76
7 31,242,968.00 22,203,794.06
8 31,242,968.00 21,146,470.53
9 31,242,968.00 20,139,495.74
10 31,242,968.00 19,180,472.14
11 31,242,968.00 18,267,116.32
12 31,242,968.00 17,397,253.64
13 31,242,968.00 16,568,812.99
Total: 387,884,534.44

Kirkland Lake Gold currently has a market cap of US$228 million. If we subtract the roughly US$70 million of net debt that the company has, as well as $36 million for the royalty, the stock is currently trading below fair value using a gold price of $1,250. This valuation analysis also doesn't include any supplemental feed from the South Claims.

If we assume 14 years of production at 200,000 ounces per year, with a $900 all-in cash costs, this upside case has the following valuation:

Upside Case

NPV(5%) = $590,159,158.36

Period Cash Flow Present Value
0 68,950,000.00 68,950,000.00
1 68,950,000.00 65,666,666.67
2 68,950,000.00 62,539,682.54
3 68,950,000.00 59,561,602.42
4 49,988,750.00 41,125,868.34
5 49,988,750.00 39,167,493.65
6 49,988,750.00 37,302,374.91
7 49,988,750.00 35,526,071.34
8 49,988,750.00 33,834,353.66
9 49,988,750.00 32,223,193.96
10 49,988,750.00 30,688,756.15
11 49,988,750.00 29,227,386.81
12 49,988,750.00 27,835,606.49
13 49,988,750.00 26,510,101.42
Total: 590,159,158.36

I think it's highly likely that the company will achieve this upside case scenario. There are just too many things in place for this not to occur.

I'm very confident in Kirkland Lake Gold's long-term potential. The grades at the SMC get better at depth, basically doubling in a few years. Also, the South Mine Complex is open at depth and along strike, which means that Macassa could be producing for a lot longer than 14 years. Not to mention the new discovery at the South Claims which could be a real game changer for Kirkland Lake. In a rising gold environment Kirkland Lake could be a multi-bagger; it was a $20 stock not too long ago.

Right now, none of this future growth or increase in cash flow is being priced into shares. The company is still probably a year away from really hitting it out of the park in terms of increased free cash flow, but it's only a matter of time and execution.

Conclusion

Kirkland Lake Gold is mining some of the highest reserve grades in the world at their Macassa Mine. The South Mine Complex at Macassa is being aggressively developed as it contains very high grade, especially at the deeper levels. In a few years the company will be mining at double the current grade levels, which will substantially boost operating cash flow and overall free cash flow. The majority of Kirkland Lake Gold's future production will come from the SMC, and given the overall resource base at Macassa, the company could be producing 200,000 ounces per year over the next 14 years.

The South Claims at Macassa could provide additional high grade supplemental feed for the 2,200 tpd mill, which would be a game changer for the company as cash cost per ton are much lower at the South Claims.

The company's stock is very undervalued at the moment, but it will be a while before they start mining the higher grade. None of this future cash flow is being priced in, but as long as the company continues to execute on this mine plan, then it's only a matter of time before the shares are re-rated higher.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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