Kirkland Lake Gold: 'It's Fosterville, Stupid!'

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About: Kirkland Lake Gold Ltd. (KL)
by: Simple Digressions
Summary

Kirkland owns two excellent assets, Fosterville and Macassa, of which the Fosterville mine seems to have greater short-term potential than Macassa.

In my opinion, Kirkland's overall performance strongly depends on Fosterville and its prospects.

In this article, I discuss the Fosterville mine - its performance, recent drilling results and an incoming catalyst.

Kirkland Lake Gold (KL) owns two excellent assets: the Fosterville and Macassa mines. However, in my opinion, of these two assets the Fosterville mine is the main engine of growth for Kirkland. In this article, I discuss this mine in detail, defending a thesis that the long-term prosperity of the company strongly depends on Fosterville's performance.

What's more, over the next few months I am going to publish a number of similar articles about flagship properties held by a few notable gold mining companies. I hope that such an approach will make the precious metals industry a bit easier for Seeking Alpha readers.

Introduction

Currently, Kirkland has four operating mines: three in Canada (Macassa, Taylor and Holt) and Fosterville in Australia. Of these four operations, the Fosterville mine is the largest one. For example, over the last three quarters of 2018, this mine produced 232 thousand ounces of gold, accounting for 47.1% of total production. The second-largest mine, Macassa, produced 170 thousand ounces.

Now, although Kirkland owns two excellent mines that can be named flagship properties (Macassa and Fosterville), it is the Fosterville mine that has the largest short-term potential. For example, in 2020, this mine should deliver 400 thousand ounces of gold (an increase of 21% compared to the 2018 production guidance). The development of Macassa will last a bit longer - a huge increase in production is expected over the next 5-7 years. As a result, today I am writing about Fosterville, but an article on Macassa is scheduled for publication a bit later.

Financial matters

Let me start with the chart below:

(Source: Simple Digressions)

The chart shows cash flow from operations (excluding movements in working capital) plotted against earnings before interest, taxes, depreciation and amortization (EBITDA - a good proxy for cash flow from operations) reported by the Fosterville mine. I guess it is easy to spot that the company’s cash flow strongly depends on Fosterville’s performance.

Now look at the earnings from mining operations reported by each mine:

(Source: Simple Digressions)

Note: Holt and Taylor are consolidated by the company under the name “Holt.”

As the chart shows, in 3Q 2018 the Fosterville mine earned $77.8 million, or 67.4% of total earnings (reported by all three operations).

Summarizing: Although Kirkland has three other assets, the leading operation is definitely Fosterville. Let me look at this mine in detail.

Fosterville

In 2016, Kirkland Lake Gold merged with an Australian company, Newmarket Gold. At that time, Newmarket had three operating mines: Fosterville, Cosmo and Stawell. However, the Fosterville mine was the jewel in the crown, delivering 60% of total gold production (130-140 thousand ounces in 2016).

Interestingly, at that time, Fosterville was just a good gold mine but not an excellent one. Then, after Newmarket was purchased by Kirkland, Fosterville started to demonstrate its tremendous potential. Look at the chart below:

(Source: Simple Digressions)

Note that until 2015, the mine was just a medium-sized operation (mineral reserves of 388 thousand ounces of gold) grading a decent 7.3 grams of gold per ton of ore. However, starting from 2016, we see a rapid conversion from decent to excellent. For example, at the end of 2016, Fosterville held 490 thousand ounces of gold in mineral reserves, while just one year later, it had 1,700 thousand ounces of gold. What's more, the average grade went up from 9.8 grams of gold per ton of ore to 23.1 g/t. As a result, the mine not only became a high-grade giant deposit but a super-low cost operation as well (the chart below):

(Source: Simple Digressions)

As the chart above shows, in 3Q 2018 the mine was producing gold at an all-in sustaining cost of production (AISC) of $416 per ounce. To remind my readers, it is not easy to find a mine producing gold at a direct cost of production below $500 per ounce, while Fosterville delivers its gold at an AISC (which is a much broader cost concept than a direct cost) of $416 per ounce.

Note that according to Kirkland:

“The Company defines AISC as the sum of operating costs, royalty expenses, sustaining capital, corporate expenses and reclamation cost accretion related to current operations”

Summarizing: Shortly after a merger between Kirkland and Newmarket Gold, the Fosterville mine became an outstanding operation producing large amounts of gold (more than 300 thousand ounces per year) at a very low cost.

Incoming catalyst

Now the best thing is, it looks like it is not the end of the story. This year, the company conducts a very ambitious exploration program at Fosterville, having drilled more than 120 thousand meters up to now. And the initial results are very impressive. For example, look at this excerpt from the news release dated September 19, 2018:

I have plotted two red arrows to indicate the most interesting holes drilled at the Swan Zone of Fosterville, which seems to be one of the best parts of the mine. The grades are outstanding - two wide holes (true widths of 5.9m-9.9m) are grading more than 155 grams of gold per ton of ore, but as is often the case, after some geological and statistical adjustments, the final grades will definitely go down.

Now, at the end of 2018, Kirkland is supposed to release a new mineral reserve estimate for Fosterville, including the results of the drilling program at the Swan Zone and a few other parts of the mine. I expect another positive surprise. Interestingly, in the news release dated November 30, the company announced:

“On a quarter-to-date basis, the mill grade at Fosterville in Q4 2018 has averaged over 35.0 grams per ton, well above target levels for the quarter. The outperformance largely relates to increased operating development activity around the Swan Zone and higher than planned grades from development tons processed”

In other words, this quarter Kirkland adjusted its mining plan, adding two high-grade stopes at the Swan Zone (grading more than 35 grams of gold per ton of ore). Since the currently mined development / stope grades are that high, the final reserve estimate should disclose a significant increase in gold grades. What's more, very often high grades result in lower costs, so it looks like the costs of production reported in 4Q 2018 are supposed to be even lower than in 3Q 2018.

Production guidance up once again

This year, following outstanding performance, the company lifted up production guidance for Fosterville several times. According to the initial estimate, the mine was supposed to produce 260-300 thousand ounces of gold (with the total Kirkland production higher than 620 thousand ounces). A few days ago, Kirkland increased the Fosterville guidance to more than 330 thousand ounces. It means that in 4Q 2018, the mine should deliver more than 98 thousand ounces of gold, the highest quarterly production in history.

Growth potential

Kirkland wants to develop its current operations, particularly the Fosterville and Macassa mines. As a result, over the next 5-7 years, the company is supposed to produce around 1 million ounces of gold per year:

(Source: Kirkland)

Specifically, Fosterville and Macassa are supposed to be delivering 400 thousand ounces of gold per year (Fosterville in 2020 and Macassa over the next 5-7 years). The other mines (Holt / Taylor and the Cosmo mine in Australia) should deliver the remaining 200 thousand ounces per year.

Risk factors

It is not easy to find risk factors specific for Kirkland. All operations are located in super safe jurisdictions: Macassa and Holt / Taylor in Canada and Fosterville in Australia. However, let me try.

Investment in Novo Resources

At the end of September 2018, Kirkland was holding 29.8 million shares (plus 14 million warrants) of Novo Resources (OTCQX:NSRPF), an exploration company operating in Western Australia. In my opinion, it is a very risky investment. The company is still searching for the gold, and up until now it has not disclosed a mineral reserve estimate. As a result, at the end of September 2018, Kirkland disclosed an unrealized loss on Novo of $15.1 million (red rectangle):

(Source: Kirkland Lake Gold)

Fosterville mineral resources

At the end of 2017, the Fosterville mine hosted 13.9 million tons of ore grading 4.8 grams of gold per ton of ore, classified as measured and indicated mineral resources (this estimate excludes mineral reserves). It has to be noted that this mineral material demonstrates a much lower grade than Fosterville reserves (grading 23.1 g/t, on average). In my opinion, it is a risk factor - assuming annual production of 350 thousand ounces of gold, the current high-grade reserves should be depleted in four years. If the company is not able to find additional high-grade material at Fosterville, the costs of production may go up significantly (as a rule, lower grades result in higher costs of production).

Valuation

The chart below shows EV / EBITDA multiples calculated for a few gold mining companies similar to Kirkland (as of December 3, 2018):

(Source: Simple Digressions)

Note that Kirkland is somewhere in the middle; currently, its shares are trading at 9.3 of its annual EBITDA. Definitely, the shares are not cheap, but keeping in mind the company’s tremendous growth potential, I think every precious metals investor should consider investing in the shares.

Summary

In my opinion, Kirkland Lake Gold is one of the world’s best gold mining companies. It holds two excellent assets (Macassa and Fosterville), of which the Fosterville mine, discussed in this article in detail, is the best one. I am confident that a company holding such excellent assets will succeed in the long term. What's more, even at a gold price of $645 per ounce, the currently operating mines should deliver a positive free cash flow (in 3Q 2018, the company was producing its gold at the consolidated AISC of $625 per ounce). Hence, in my opinion, Kirkland shares should be of great interest to any investor looking for exposure to the precious metals market.

Disclosure: I am/we are long CEF, GDX, KL, SAND, ARREF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.