It’s been a busy few months for Kirkland Lake Gold (KL), with the company announcing record full-year gold production last week and acquiring Detour Gold (OTCPK:DRGDF) in Q4, with the deal very likely to close without an opposing suitor. While the acquisition will give a massive boost to Kirkland Lake Gold’s annual production, assuming it closes, the deal has not been accretive to Kirkland Lake Gold’s earnings growth metrics, which have evaporated based on analyst estimates. Kirkland Lake Gold managed to grow annual EPS 170% on average between 2016 and 2018, but annual earnings per share growth is likely to slow to single-digit levels for FY-2020. I continue to see a minor upside in Kirkland Lake Gold from the $44.00 level, but valuation may become an issue if the stock continues to rally. Based on this, I would view any rallies above the $50.00 level as opportunities for investors to lighten up their exposure in the stock.
There’s been much disagreement about the Detour Gold deal, and whether it was a positive move for Kirkland Lake Gold. When it comes to the acquisition from a long-term standpoint, it’s very likely a win, as this management team has proven over and over again that they are a long-term winner. Kirkland Lake Gold added eight years of mine reserves with the deal, they have de-risked their reliance on new discoveries from Fosterville, and they’ve increased annual production while sticking to their focus on tier-1 operating jurisdictions. Based on these points alone, long-term shareholders of three years or longer should be rewarded by the deal. However, when it comes to a medium-term basis (12-18 months), it’s less clear whether this deal was indeed a win.
(Source: Kirkland Lake Gold Company Presentation)
Kirkland Lake Gold paid $239.29/oz for Detour Gold based on the company’s 15.4 million ounces, a figure that was significantly above the five-year average paid for gold producers in tier-1 jurisdictions. One could argue that the higher gold price accounts for the premium paid. Still, St. Barbara acquired Atlantic Gold (OTCPK:SPVEF), the second-lowest-cost producer in North America, earlier this year at $239.00/oz. Given that Kirkland Lake Gold is acquiring one of the higher grade producers in Detour Gold with costs 80% higher than those of Atlantic Gold, it’s hard to argue that they got a deal. Atlantic Gold was producing at less than $550/oz, and Detour Gold is currently producing at over $1,000/oz based on all-in sustaining costs for its past nine months of production. Even if we assume Detour Gold can get costs to below $900/oz under Kirkland Lake Gold, this was still a high-cost acquisition being completed at the same price as one of the lowest-cost producers in the space.
We can argue until we’re blue in the face about why the deal was or wasn’t done at a great price, but numbers do not lie, and one thing is for sure. This deal for Kirkland Lake Gold has been a massive drag on earnings growth and has derailed it from the only hyper-growth gold company to a no-growth company from an earnings standpoint at the same time that the industry is transitioning back to high earnings growth. This is not ideal for Kirkland Lake Gold as it used to be the shining star in the sector, and it’s now moved off the radar of not only growth funds across all sectors but also funds looking for earnings growth in the gold sector. Let’s take a closer look at what I mean below:
NOVEMBER 2019 ESTIMATES
JANUARY 2019 ESTIMATES
At the beginning of December, I shared the chart above and explained that Kirkland Lake Gold’s annual EPS was likely to screech to a halt following this acquisition. While the growth in FY-2020 was tepid at single-digit levels, the recent earnings estimates revisions have painted an even uglier picture in terms of growth. As we can see from the second chart above, while FY-2019 earnings estimates have remained steady at $2.69, FY-2020 earnings estimates have dropped considerably from $2.92 to $2.74. This translates to only 2% earnings growth year over year from the prior 9% projections at $2.92. This drop-off has revoked Kirkland Lake Gold’s previous title as the top company for earnings growth in the sector in 2019 to one of the bottom 20% of earnings growers for FY-2020.
If we put this 2% earnings growth in perspective, Barrick Gold’s (GOLD) annual EPS is expected to grow 24%, Agnico Eagle’s (AEM) annual EPS is expected to grow 86%, and Newmont’s (NYSE:NEM) annual EPS is expected to grow 47%. Of these three majors, their average annual EPS growth rate for FY-2020 is forecasted to come in at 52%, with a median of 47%. Therefore, of the major gold miners in tier-1 jurisdictions, Kirkland Lake Gold is now the weakest from an earnings growth standpoint by a wide margin.
If we look out further to FY-2021, we also saw earnings estimates slashed recently, with forecasts dropping from $3.13 to $2.92. This would translate to only 7% growth in annual EPS for Kirkland Lake Gold, a dramatic shift from the strong double-digit to triple-digit growth rates the company enjoyed between 2015 and 2018. Therefore, barring a significant move in the price of gold (GLD), Kirkland Lake Gold will struggle to put up better than high single-digit growth for the next two years. Not only does this rescind the company’s status as a top 100 growth stock on the US market but also as an earnings grower within the gold sector.
Many investors will likely argue that these estimates are not factoring in a scenario with a gold price trading at $1,600/oz-$2,000/oz in FY-2021, but I would argue that all of the gold majors will benefit just as much, if not more, from a higher gold price. Therefore, while a higher gold price is a possibility, though not something I would base an investment decision around, the same benefit would apply to all gold majors. If we take a conservative approach and assume an average gold price of $1,550/oz, Kirkland Lake Gold is much less attractive than its gold major peers.
So why does this matter? Let’s take a look at the company’s valuation below:
As we can see from the chart above, Kirkland Lake Gold has had a difficult time getting over a forward earnings multiple of 18 in the past, with this level prompting the August 2018 correction, as well as the August 2019 correction. Even though Kirkland Lake Gold is more than 12% below its all-time highs, valuation has barely improved due to the recent revision in earnings estimates. This is because the valuation was previously factoring in annual EPS above $3.05 for FY-2020 in August, and these estimates have dropped 10% since.
Therefore, while Kirkland Lake Gold may look extremely cheap at a forward earnings multiple near 16.80, I would argue that the stock would begin to get expensive based on its historical range at an earnings multiple above 18. Based on this, the stock does provide some minor value here at $44.00 but is not very attractive above the $50.00 level where its forward earnings multiple would head back over 18. The only two things that would fix this would be a gold price showing commitment above $1,650/oz, or analysts revising their earnings estimates dramatically higher.
In summary, there is no question that Kirkland Lake Gold’s decision to buy Detour Gold was a wise one on a long-term basis (3+ years). Still, it’s dethroned the stock from its seat as a top-100 growth stock, and the most robust earnings grower in the sector almost overnight. The better option would have been paying less for Detour Gold as this would have made the deal be less of a drag on earnings per share. The other option would have been making a smaller acquisition and using strategic share buybacks to drive further annual EPS growth even with growth rates slowing slightly. Unfortunately, neither of these scenarios was the case, and I believe they slightly overpaid for a decent asset. This has allowed other gold majors to get some attention from funds in a sector where it was previously “Kirkland Lake Gold or own the index” as the mantra.
While all of this may seem like my opinion and is certainly up for debate, the earnings per share growth do not lie, and neither do the technicals. As the chart below shows, Kirkland Lake Gold’s relative strength vs. the Gold Miners Index (GDX) finally broke down following the acquisition, with the ratio breaking both its 200-day moving average and the multi-year uptrend line. This uptrend line break has not been a temporary reaction that’s quickly corrected but instead looks to be a material breakdown, suggesting that the stock will move from a market out-performer to a market performer over the short-run (6-9 months).
If we look at Kirkland Lake Gold vs. another gold major, Newmont, we can see the same trend shift potentially occurring. As the chart below shows, Newmont was massively lagging Kirkland Lake Gold since 2017, but this ratio has now begun a new uptrend with the 200-day moving average attempting to turn around finally. Also, the downtrend line in this ratio has broken out, suggesting the potential for Newmont to begin outperforming Kirkland Lake Gold going forward. Newmont’s annual EPS growth of 47% next year, combined with a plan to increase its dividend by 79%, could undoubtedly provide catalysts for this.
Kirkland Lake Gold continues to have one of the best management teams in the sector, and one of the most attractive assets, but it’s hard to argue the stock will be an out-performer with earnings growth practically non-existent for FY-2020 and FY-2020. Based on this, while I am not bearish on the stock by any means, I do believe that investors would be wise to lighten up exposure if the stock heads back above the $50.00 level.
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.