A Gold Miner With Tremendous Upside...

I recently headed up to New York for Gabelli’s Best Ideas Conference. The format is simple. The Gabelli team gathers up their best ideas and brings in the CEOs and CFOs of those companies to present to the attendees and answer questions. I’ve been coming for several years and always walk away with at least a handful of ideas I find intriguing.

It is a great pool to pick from, as the Gabelli team are proven stock pickers. My readers have done well picking up names here in the past. In 2009, I picked up Bowne for the portfolio after watching it present and after meeting the CEO. It was bought out 78 days later for a 78% gain. In 2010, I recommended another company that nearly doubled. I missed the conference in 2011, and here we are with findings from the 2012 conference. I’ve got several names I’m still looking over, but the first presenter of the day was the CEO of one company I’ve already green-lighted to my readers.

Kirkland Lake Gold (KGI) is a single-asset gold miner. It operates a high-grade mine in the town of Kirkland Lake in northern Ontario. My readers and I had quite a ride with this one. It more than doubled for us, after which we took half off the table (wisely, it turned out). Since then, Kirkland’s stock has round-tripped and is now below my initial recommendation in May 2010.

Brian Hinchcliffe is the CEO and talked to the group. He started his career at J. Aron, which Goldman Sachs later acquired. He then became a “mineral entrepreneur” and founded Jordex Resources with Harry Dobson (current chairman of Kirkland). Anglo-American acquired Jordex for $65 million, and investors did well. Kirkland is the duo’s latest venture. Management owns about 20% of the company. So it is, as Brian said, “a big, important asset to us.”

Kirkland will produce about 100,000 ounces of gold this year from an underground mine at a cost of about $800 an ounce. Kirkland’s biggest cost far and away is labor (about 65% of total costs). That is typical of an underground mine and different from an open-pit mine, for which the biggest cost is energy. Power is only about 12% of total costs for Kirkland. It has a long-term contract in place for power at only 4 cents per kilowatt hour, which is a good rate.

As Brian said, Kirkland will never be a low-cost miner, but should be in the middle of the curve. At $1,700 gold, Kirkland ought to produce plenty of cash, especially after it completes adding to its hoisting capacity at the mine, which will bring production to 200,000–250,000 ounces in 2013.

Here is the problem, though: Kirkland has suffered numerous delays and challenges in getting there. The most recent stumble sent the shares tumbling. I expect plenty of shareholders threw in the towel in frustration. But this is par for the course with gold juniors. There are always delays. Things never seem to go quite as planned. The upside here, though, is worth hanging around for. When Kirkland gets through this, it will produce a lot of cash.

So this year, production will look a lot like it did last year. That’s a disappointment, but the original plan is still in play. “We’ve had a number of delays” Brian says, “Some of it was just bad luck. We had forest fires — the whole province had forest fires — in May. There were a few things like that that were completely out of our control.”

“We’re making money, but not a lot of money,” he continued. “But next year — meaning beginning with May 1, 2013 through April 30, 2014 — will likely have the kind of scenario we wanted to have this year.” Note: Kirkland’s fiscal year is April 30.

The company has largely completed the work of adding to the hoisting capacity at the mine, but the delays mean that Kirkland essentially lost a year. Once complete, as I say, Kirkland ought to get to 200,000-plus ounces per day — more than doubling its current production.

I asked Brian what Kirkland planned to do with the cash they’ll generate when they get there and how he thought about allocating that money. Too often, gold miners put it right back into the ground or buy another miner. But I’ve always liked Kirkland because the insiders own 20% of the stock. And they are successful businessmen, not geologists who get excited over ore bodies.

Brian’s answer was a good one: Pay dividends.

“Historically, gold mining companies paid dividends,” he said. “I think you could also argue that the gold mining industry… has forgotten the importance of dividends in the overall strategy of the mining sector. Once we [at Kirkland] get started paying one, it can’t be a meaningless dividend. It’s gotta be something that offsets the risk of investing in a highly cyclical, capital-intensive business. So it’s got to be north of a 5–6% yield. We’d start conservatively, but this is what we’ve done with companies we’ve owned in the past. And this is, again, historically what mining companies did. I think gold miners will be forced back into that paradigm.”

Brian also has no desire to acquire other gold companies to expand the business. (Hear, hear!) Kirkland is in it for the long haul, as Brian emphasized. It has a 20-year mine life. There are no delusions of grandeur. No desire to head off to Mexico or explore Peru. The endgame for Kirkland is to get to a steady state of production at 200,000-plus ounces and pay a good dividend.

Kirkland is worth buying again and — as I told my readers recently — riding back to $18 per share.

I say again, as I always say with these speculative miners and resource companies: It is risky. The business itself is fraught with peril. (The last 12 months prove it all over again.) So please be careful how much you buy. Buy it only with money you can afford to lose.

With that warning out of the way, I do think Kirkland offers tremendous upside.

Sincerely,
Chris Mayer

Original article posted on Daily Resource Hunter