It’s been a roller-coaster ride for many gold miners (GDX) this year, and Kirkland Lake Gold’s (KL) high-margin operations haven’t shielded the company from the overall market turbulence. In fact, the stock was one of the names that was hit the worst during the correction in the major market averages (SPY), falling 65% from its prior all-time high. While Kirkland Lake’s increased annual dividend and transition to a 1.5 million-ounce producer have undoubtedly made the stock more attractive among the other major gold producers, the stock has come a long way since its March 16th low. This doesn’t mean that the stock’s rally can’t continue, but the reward to risk will no longer be attractive if this rally extends for another 10%. Based on this, I would view any rallies above the $41.00 level as an area to book some profits.
Kirkland Lake Gold was the lowest-cost gold producer to finish FY-2019, an incredible feat for a company that has continued to execute nearly flawlessly over the past few years. From a brilliant takeover of Newmarket Gold to consistently beating operating metrics across the board at its mines, it’s hard to find a single misstep by management since 2015. However, the acquisition of Detour Gold (OTCPK:DRGDF) in late 2019 sacrificed the company’s industry-leading margins for production growth, and this has led to the company taking a backseat for performance among the other major gold producers. In addition, it’s dethroned the company from its top-ranked spot among the gold producers from a cost standpoint, as the company will likely tumble from a #1 rank to a #13 to #15 rank after integrating Detour Lake’s high-cost operations in FY-2020. While this isn’t a deal-breaker for the investment thesis by any means, it should help explain the company’s poor performance vs. its benchmark over the past nine months. Let’s take a quick look at the FY-2019 results below:
Kirkland Lake Gold released its Q4 and FY-2019 earnings report on February 20th, and the company trounced its initial production guidance of 960,000 ounces, and came in just above the high-end of its cost guidance last year. The company reported annual gold production of 974,000 ounces for FY-2019, at all-in sustaining costs of $564/oz. While all-in sustaining costs of $564/oz were slightly above guidance, it’s worth noting that the company was forecasting the lowest costs in the industry, an extremely high bar to set going into the year. Whether the company missed slightly or not, these cost figures were exceptional when compared to the industry average, which came in at $980/oz for FY-2019. In terms of production growth, it was another massive year for the company, as annual gold production grew by 34% in FY-2019, from 723,000 ounces to 974,000 ounces. This is even more impressive considering that the company was already lapping a year of 21% production growth (596,000 ounces vs. 723,000 ounces). Therefore, from an operational standpoint, it’s hard to find any miner in FY-2019 that put up results even in the same league as Kirkland Lake.
Moving over to the company’s earnings trend, the company has been a clear leader in the sector for years, and managed to grow annual earnings per share (EPS) from $0.52 in FY-2016 to $2.71 in FY-2019, representing growth of more than 400% in this period. However, while triple-digit growth rates used to be commonplace, they are now a thing of the past; instead, even double-digit earnings growth rates will be hard to come by looking forward. As we can see from the chart below, annual EPS is expected to come in at $2.80 for FY-2020, representing growth of only 4% year over year. I pointed this out in my January article “Kirkland Lake Gold: Earnings Estimates Continue To Slide,” and warned that there was little upside from the $44.00 level at the time, while others were pounding the table that the stock was a buy on any weakness. As we can see when comparing the two charts below, earnings estimates have been pulled higher a little for FY-2020, from $2.74 to $2.80, but this will still translate to mid-single-digit growth, an extremely underwhelming earnings growth rate when the industry’s earnings growth rate for FY-2020 is forecasted to be over 35%.
If we look out further to the FY-2021 estimates, we’re on track to see another year of relatively dismal growth, given that the FY-2021 annual EPS forecast is currently sitting at $2.90. Some investors might wonder how it’s possible that the company could see such minimal growth for FY-2020 and FY-2021 even with a higher gold (GLD) price, and the answer is that the earnings, which have grown massively with the addition of Detour Gold, are being divided over a larger share count post-acquisition. Prior to the Detour Gold acquisition, the company’s share count was 210 million shares, and since, it has grown to 284 million shares, an increase of 35%. Therefore, the key to earnings growth going forward for Kirkland Lake Gold will be optimizing operations at Detour Lake and getting costs below $900/oz to drive margin expansion. This would help to bolster earnings, as gross margins are likely to drop from above 65% in Q4 2019, to below 50% in the first half of 2020.
Unfortunately, the company had to suspend operations at its Holt Complex just recently, and also reduced operations at Macassa and Detour Lake. These decisions came due to the fear of COVID-19 spread, and for now, Holt operations are expected to be suspended until April 30th. Meanwhile, Macassa is also expected to run on reduced operations until April 30th. The good news is that Fosterville, the company’s backbone, has not seen any interruption in operations to date. Based on FY-2020 guidance, Fosterville is expected to deliver annual gold production of 600,000 ounces, making up 40% of the company’s production this year. Therefore, while the reduced operations at Holt, Macassa and Detour Lake are a setback, the fact that Fosterville remains open certainly offsets some of this interruption. Having said that, I would be shocked if Kirkland Lake managed to produce over 1.4 million ounces in FY-2020, which certainly jives with the lukewarm earnings estimates of $2.80, despite a higher gold price.
The good news, which I’d be remiss to ignore, is that the company increased its annual dividend to $0.50 recently. This 100% increase in the annual dividend from $0.25 to $0.50 makes the company much more competitive among the gold majors, as Kirkland Lake used to have one of the lowest dividend yields. Based on the current share price of $35.60, Kirkland Lake’s dividend yield is 1.40%, right in line with Barrick Gold’s (GOLD) current yield of 1.40%, and just below Yamana Gold’s (AUY) dividend yield of 1.50%. Therefore, from an investment standpoint, the stock is undoubtedly more desirable here with a solid yield and exceptional margins. The other piece of good news is that the company has been actively buying back shares, with 10.1 million shares purchased for $350 million. This should decrease the share count and allow for higher annual EPS going forward, given that the share count could be back below 270 million shares by the end of 2020. However, the company certainly didn’t get a great price for their shares, as their average cost on those 10.1 million shares is $34.65, and the company has only broken even on their purchases after a 90% rally. Let’s move over to the technical picture below:
As we can see in the monthly chart below, the stock had managed to find immediate support at its 8-month moving average on all prior pullbacks, but finally failed at this level in January of this year. This is a significant change of character, especially considering that this wasn’t a minor failure below this level, but instead a massive one. Based on this failure, the stock is now neutral on its monthly chart for the first time in over five years, and this suggests that sharp rallies back to this area may run into selling pressure. Currently, the 8-month moving average sits just above the $41.00 level, and the first area of strong resistance for the stock.
If we move over to the weekly chart, things are just as complicated, as this nearly 100% rally off of the lows has not done much to improve the technical picture. In fact, Kirkland Lake Gold remains in an intermediate downtrend for the time being, and is also still below its prior multi-month support at $40.20. Often, strong support levels will morph into new resistance levels, and it’s possible that the $40.20 to $41.00 area could be a very difficult spot for the stock to get through if we head there before June. Therefore, I would view rallies above $41.00 as an opportune spot to take some profits.
Kirkland Lake Gold was previously the only real darling of the sector, but it’s hard to argue that the company is the sector leader going forward. While the company has a bright future as a 1.5 million-ounce producer, especially if it can get costs below $800/oz at Detour Lake, the company’s earnings growth rate is likely to lag the sector massively for FY-2020 and FY-2021. The company’s underwhelming annual EPS growth and margin compression suggest that a rally above the $41.00 level would be an area where it might be wise to take some profits. For now, I see better opportunities elsewhere in the sector and see no reason to chase the stock at current levels above $35.50.
Disclosure: I am/we are long GLD. 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.
Additional disclosure: 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.