Kinross: Enviable Project Pipeline Offset By Operational Setbacks

Summary

• Kinross Gold is one of the worst-performing senior gold producers since Q3 2020, down more than 41% vs. a 30% decline in the Gold Miners Index.
• The underperformance can be tied to setbacks related to pit instability at Round Mountain, and a fire at the company's flagship Tasiast operation that has sidelined the mill until Q4.
• However, at a P/NAV ratio of just over 0.80x, these setbacks look to be mostly priced in, especially considering the meaningful growth from key projects over the next few years.
• Given Kinross' reasonable valuation and solid growth outlook, if it can execute on key projects, I would view any pullbacks below US$5.20 as low-risk buying opportunities.

Paul-Briden/iStock via Getty Images

The Q3 Earnings Season has finally begun and the results have been mixed, given that the sector is up against tough year-over-year comps due to the record gold price in Q3 2020. Kinross Gold (NYSE:KGC) is getting ready to release its Q3 results this month, and we should see a sharp decline in revenue year-over-year with a much lower contribution from Tasiast, and the company is working with a much lower average realized gold (GLD) price. The good news is that the softer year and guidance cut looks mostly priced into the stock, and the outlook is brighter if we look ahead to 2023. Given Kinross' reasonable valuation and solid growth outlook, if it can execute on key projects, I would view pullbacks below US$5.20 as low-risk buying opportunities.

(Source: Company Presentation)

Kinross' Q2 results left a lot to be desired, with much lower production from Tasiast due to a mill fire that was reported in June that resulted in a suspension of milling operations. This led to a nearly 30% decline in production from Tasiast in the period, pulling production down to just ~538,100 gold-equivalent ounces [GEOs], the company's weakest quarter in the past several years. Unfortunately, with the mill not expected to restart until some point this quarter, the Q3 results are likely to be impacted significantly, with no contribution from this #3 asset from a production standpoint (just behind Paracatu and Kupol). Let's take a closer look below:

(Source: Company Filings, Author's Chart)

As shown in the chart above, production fell sharply at Tasiast (red bar) in Q2, and the mine is not expected to contribute any meaningful production in H2 2021. This led to a guidance cut to ~2.1 million GEOs, down from an outlook of ~2.4 million GEOs previously, with production now expected to be more than 15% below FY2019 levels, which came in at ~2.51 million GEOs. Meanwhile, it hasn't been a great year at Round Mountain either, with the priority being mitigating north wall instability at the Nevada operation, which was detected in Q1. This deferred access to higher grade Phase W ore. While the wall has been stabilized, these two major setbacks will undoubtedly weigh on H2 2021 results, and it's likely we'll see much higher costs on a year-over-year basis in Q3 due to fewer gold sales and moderate inflationary pressures cited by the company.

(Source: Company Filings, Author's Chart)

Looking at the company's margins above, we can see that Kinross has seen a steady increase in all-in sustaining cost [AISC] margins since Q4 2019, with AISC margins soaring to $947/oz in Q3 2020 and coming in at $862/oz in Q4 2020, translating to a 98% increase year-over-year. Unfortunately, the gold price tailwind that was present last year is a headwind this time around, with AISC margins dipping for their third quarter in a row in Q2 2021 and a fourth consecutive quarter of margin compression looking likely in Q3. This is because the average realized gold price sector-wide looks to have come in at closer to ~$1,785/oz, and Kinross' all-in sustaining costs are likely to come in above $1,090/oz in the quarter.

This would translate to AISC margins of less than $700/oz, or a 25% plus decline on a year-over-year (Q3 2020: $947/oz). With Kinross' Q4 2020 average realized gold price coming in $1,875/oz and a high likelihood of an average realized gold price of less than $1,850/oz in Q4 2021 combined with higher costs due to minimal contribution from Tasiast, Kinross' will be up against difficult year-over-year comps in Q4 as well. As shown below, the same is true for revenue, with Kinross' revenue expected to come in below $940 million in Q3, a more than 15% decline from ~$1.13 billion in Q3.

(Source: Company Filings, Author's Chart)

So, what's the good news?

As shown below, Kinross has an enviable organic growth pipeline, with the Tasiast Mill expected to ramp up to 21,000 tonnes per day early next year, with further growth to 24,000 tonnes per day in mid-2023. Meanwhile, the company's La Coipa Project is expected to come online next year and is set to produce over 600,000 GEOs over a 3-year period at AISC below $700/oz. Finally, Manh Choh, a high-grade project in Alaska, is expected to begin production in 2024, with ore being trucked to its Fort Knox mill. Kinross owns 70% of Manh Choh, and this will be another meaningful contributor to annual production. Assuming the company can execute successfully on its development pipeline, production should increase to ~2.9 million GEOs in 2023 and remain above 2.5 million GEOs looking out until 2030.

(Source: Company Presentation)

On the surface, growth from ~2.1 million GEOs to ~2.9 million GEOs is incredible, translating to a 17.5% compound annual production growth rate which is unheard of among the senior producers. However, it's important to note that this growth is occurring after a material decline in production. The actual compound annual growth rate is 3.4% if we measure back from 2018, when the company produced ~2.45 million GEOs. If we look back to 2016, the growth is even less impressive, with Kinross producing ~2.79 million GEOs in 2016, translating to a ~0.6% compound annual production growth rate looking ahead to the FY2023 production goal of ~2.9 million GEOs. Therefore, while we can call this growth, I would argue that it's more of a recovery of a declining production profile. The good news is that at least Manh Choh and La Coipa are relatively low-capex projects, estimated at $400 million combined for the two projects.

(Source: Company Filings, Author's Chart)

In the gold sector, the best companies are those that can consistently grow production per share, and while Kinross' outlook above is certainly attractive, production growth per share has not been a strong suit for the company. If we look back on an 11-year basis, Kinross produced ~538,200 GEOs in Q2 2010 with just over 700 million shares outstanding. Assuming that Kinross can produce ~700,000 GEOs in Q2 2023, this would translate to a 30% production growth rate in the 11-year period. However, the share count has grown from ~702 million shares to ~1.27 billion shares outstanding, meaning that while production will grow by 30%, the share count has increased more than 80%.

If Kinross' is aggressive with its current 5% buyback program to buy back up to ~60 million shares, the company can improve these metrics, but as it stands, production per share will go from 1 ounce produced per 1,304 shares (Q2 2010) to 1 ounce produced per 1,814 shares assuming a flat share count looking out to Q2 2023. In comparison, Agnico Eagle (AEM) has grown production from ~257,000 ounces in Q2 2010 to estimates of ~570,000 ounces in Q2 2023, with its share count going from 160 million shares to 244 million shares in the period. This means that Agnico was producing 1 ounce of gold per 623 shares in Q2 2010, and it's set to produce 1 ounce of gold per 428 shares in Q2 2023, translating to exceptional growth in production per share. This makes Agnico a stand-out name among its peers and a clear reason why the stock trades at a premium to its peer group, combined with its predominantly Tier-1 jurisdiction profile.

(Source: Company Presentation)

So, is Kinross a Buy?

As the chart above shows, Kinross is relatively cheap compared to its peer group, partially related to just ~30% of production coming from Tier-1 jurisdictions (Fort Knox, Round Mountain, Bald Mountain), and partially due to its slightly higher costs vs. names like Barrick Gold (GOLD). At a current P/NAV ratio of just above 0.80x, I would argue that Kinross certainly has upside over the next two years. Plus, total returns will be boosted by more shareholder-friendly capital allocation plans, including the reinstatement of its dividend last year and plans to buy back shares. However, while the stock has upside fundamentally and has some margin of safety baked in, the technical picture has soured due to the guidance cut following the unexpected mill fire at Tasiast.

(Source: TC2000.com)

As we can see from the chart above, the $6.90 level was rock-solid support for the stock between November and February. The undercut of this support in March was not a huge deal, as the stock immediately reclaimed this level with a vengeance. However, this level was broken violently in June, confirmed by new 52-week lows, and this area has now become a new potential resistance level. This has weighed materially on the reward/risk outlook from a technical standpoint, with upside to resistance compressed due to this new support area. Meanwhile, the next strong support area is now at $4.75, more than 20% below current levels. The technical outlook doesn't mean that the stock has to drop this low (to $4.75 support), but with Kinross in the upper portion of its potential trading range (support vs. resistance) at a share price of $6.00, the reward/risk is less favorable than preferred.

Generally, when it comes to buying sector laggards, I prefer a minimum reward/risk ratio of 4 to 1. After the operational setbacks, Kinross is an industry laggard, at least until it gets things back on track in early 2022. For Kinross to improve to a near 4 to 1 reward risk/ratio between support and resistance, the stock would need to dip below $5.20 per share, where it would have less than $0.45 in downside to strong support and more than $1.70 in upside to resistance. So, at a current share price of $6.00, I don't see a low-risk buy opportunity here, even if Kinross is valued at the right price if it can execute on its plans.

(Source: Company Presentation)

Kinross has a much better two years ahead, and with the company hopefully putting its buyback program to good use opportunistically, the company's production growth per share metrics should steadily improve looking out to 2024. However, given the soured technical picture, I recently exited my position for break-even above $6.50 per share. If the stock were to pull back below $5.20, I would strongly consider starting a position in the stock. However, for now, I see better opportunities elsewhere in the sector.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of GLD, AEM either through stock ownership, options, or other derivatives. 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.

Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.