Kirkland Lake Gold – Lakewood Capital Short Idea – My Perspective

Kirkland Lake Gold is a new short by Lakewood Capital, according to a 1Q letter Bloomberg obtained. In their thesis, Lakewood sees “potential downside to $17 per share as the stock has swelled to levels far in excess of its underlying asset value.”  

While I have not seen the report, I did some back of the envelope math using the $17 price target they arrived at to see what Kirkland Lake would look like at Lakewood’s worst-case price objective.  

KL has 210 million shares outstanding. The current market cap based on yesterday’s close of $31.10 is $6.6B. At $17, that would imply a $3.6B market cap. 

From there, just to have a little fun and overly-illustrate a point, I subtracted cash estimates that the company has internally forecasted to have on the balance sheet by 2021 of $1.5B. Given the company has no debt, a $17 price target would essentially mean that the rest of Kirkland Lake Gold’s assets are worth just $2B. 

That’s a very aggressive price objective. For one, the latest 43-101 for Macassa illustrated that Macassa’s NPV had an indicated value of $1.7B using a 5% discount and a $1,230 gold price.

While I realize this is not how the math gets reconciled, for sake of simplification, Macassa NPV plus cash on balance sheet by 2021 is alone worth Lakewood’s price target of nearly $17 a share.

What about the rest of the company? Which includes Fosterville, Holt, Halloway, Taylor, Northern Territory, et al?

Before even addressing those, it is important to remember that Macassa has a long life and the very essence of the new shaft is to be able to convert inferred mineral resources into reserves and have better access to that portion of the deposit and thus improved productivity and production. The shaft will also help with future exploration initiatives.

Next, Fosterville does not shut down after 2021 as the price target of $17 suggests. Fosterville has 2.7M in reserves as of December 31, 2018. The Swan zone accounts for more than 80% of it. Using KL’s own 575k ounce 3-year production run rate guidance would imply at least a 5 year mine life based solely on current reserves.

Is it reasonable to assume that Fosterville’s High Grade Swan zone is fully depleted by the end of this time? The short thesis seems to suggest so based on the math applied above.

The bigger question one should be asking is can KL replicate another Swan Zone? I can say that after following the company for as long as I have and reading Fosterville’s 43-101 technical report, the following statements from the “Interpretation and Conclusions” section gives me reason to believe there is more beyond what today’s current reserves indicate and perhaps reveals why the Kirkland Lake management team seems optimistic beyond the December 31, 2018 reserve update snapshot in time:

With respects to Swan Zone specifically, maximum plunge extent has not yet been defined:

  • Continued drill definition of these structures over 2018, in combination with ore development and production exposure and reconciliation performance has reaffirmed the significance of footwall structures to the Lower Phoenix (Benu) Fault. The defined continuity, proximity to existing Mineral Resources and high-grade tenor of these structures enhances the December 2018 Mineral Resource and Reserve position. Furthermore, mineralization on these structures is open down-plunge, providing encouraging future Mineral Resource and Mineral Reserve growth potential for the Fosterville operation (Page 232 of the technical report). 

With respects to Harrier specifically, characteristics similar to Lower Phoenix (Swan) should not be overlooked:

  • The high-grade visible gold mineralization was first recognized at approximately the 4480mRL, a comparable elevation to where visible gold occurrences in the Lower Phoenix became more prominent. The Harrier Base mineralization is open down dip and down plunge to the south (Page 232 technical report).

With respects to other areas within the Fosterville land-package, it is not just Swan and Harrier:

  • There is an observed change in the nature of some of the Fosterville mineralization at depth with a number of high-grade, quartz-carbonate +/- stibnite vein hosted, visible gold drill intercepts recorded for the Swan, Eagle, Lower Phoenix, Lower Phoenix Footwall, East Dipping and Harrier Zones. In addition, visible gold occurrences have been observed at depth in the Robbin’s Hill system in the north-east of the mining lease on a separate line of mineralization (Page 233 technical report).
  • Regional exploration drilling programs have been successful in increasing the strike length of known mineralized systems from ~11km to ~15km (including Goornong, Mill’s, Fosterville, Robbin’s Hill and O’Dwyer’s). In addition, programs have, confirmed the presence of gold bearing sulfide mineralization at May Reef and Lyell and identified 2 previously undiscovered lines of mineralization to the east of Goornong and to the west of Russell’s Reef (Page 233 technical report).

With respects to one of the risks pointed out which I thought was interesting:

  • A foreseeable risk and uncertainty facing the operation is the changing character of mineralization at depth with an increase in the occurrence of visible gold. Reconciliation results in the past have provided confidence in the sample collection procedures, the quality of assays and the resource estimation methodology, but these processes will need to be continually adapted / refined in consideration of the changing mineralization character at depth (Page 234 technical report).

As you can see, based on the foregoing, the faith of Fosterville is not riding entirely on the Swan Zone. The limits of this high grade zone has not been fully realized as it remains open. In addition to Swan, there are other encouraging high grade targets such as Harrier, Robbin’s Hill and numerous other zones within the broad land package that has legitimate potential.

As such, I cannot envision Fosterville’s high grade swan system being modeled as a short lived outcome and tied to current reserves like Lakewood is suggesting. For Lakewood’s thesis to entirely come to fruition, it would require zero additional high grade reserve growth, which I think is a stretch to say the least based on the underlying geological fundamentals.

As for Chairman Sprott resigning from the board and selling some stock, that is certainly something to take note of. But it would have to be evaluated with other facts to reconcile it. Such as the fact that this was a 5-10x investment for him and the fact that he still owns a material amount. At last check, he’s only sold 1.5m shares, a paltry sum of the total. Sprott is also in his 70s. You would think after minting all the money that he did, he would take some off the table and de-emphasize the work-life balance a little. That’s prudent risk management and no stranger to investment guidelines adopted by all the investment and hedge funds out there.

The prior CFO leaving and using that as an argument to support the bear thesis is interesting to say the least. I have met both CFOs and I am actually indifferent about the transition. Phil Yee left in July of 2018 back when KL stock was around $22. Regretfully, he sure missed a nice run. In mining, I put more emphasis on geologists leaving or the CEO. Tony Makuch is still there and he’s a geologist. Ian Holland is still there and he is the VP of Operations at Fosterville and has been there since 2007 and witnessed the transformation of the grade tenor. These would be the type of high profile departures at Kirkland Lake that would concern me, not this one. I can understand the concern if there were financial irregularities going on but this is not the case here. Yee wasn’t a geologist, either, at last check.

At current valuation, Kirkland Lake needs to demonstrate it can replicate another Swan, or at the very least continue extending the Swan Zone’s mineral endowment. There is no denying that on my end. But the idea that the high grade tenor is a short mine life and therefore the stock is worth $17 is quite a statement.

There is no doubt that a lot of future success has been priced in. This leaves for a smaller margin of error to work with. I would argue that a pullback is considered healthy and welcomed to allow the story to catch up to the stock price. After all, the stock has outperformed every other mining stock in the universe since 2016 and the theme has matured quite a bit.

Is that enough to call it a short play? Sure, that’s what makes a market. It is after all a gold stock; the sector continues to be unloved; and Kirkland Lake is no stranger to market corrections having had instances of up to 30% in the past. But I wouldn’t be quick to bet on Fosterville’s demise just yet.

Kirkland Lake’s AGM is upcoming. I’m sure we will get an exploration update shortly to evaluate it some more.

I end with this. Always harvest profits, it is mining after all.


2 thoughts on “Kirkland Lake Gold – Lakewood Capital Short Idea – My Perspective

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