Kirkland Lake Gold (TSX:KL)(NYSE:KL) is one of my favourite gold stocks of all time.
At the start of 2019, I’d highlighted a hidden cash flow opportunity that the market was ignoring. “There’s a secret ingredient that few investors are talking about, but it has the potential to scale massive amounts of free cash flow from rising profits,” I wrote.
I’d concluded that 2019 would be Kirkland Lake’s best year on record. Over the next 12 months, shares skyrocketed by nearly 60%.
Recently, I named the company my top gold stock for 2020. Many of the same factors are still in play, but, interestingly enough, Kirkland Lake may experience a big transition, one that turns it from a growth stock into a dividend stock.
Look at this business
Gold stocks are notorious for burning through shareholder capital. The reason behind this is basic human weakness.
As you’re likely aware, commodities regularly experience boom and bust cycles. When prices are rising, revenue soars. Undeveloped projects are suddenly very profitable, at least on paper. Gold miners rush to sell stock and take on debt to fund these new ventures.
When prices are at their zenith, industry funding is also at its peak, meaning miners invest the most just as their prospects are about to crash. When commodity prices do fall, these firms sell assets at fire-sale prices to shore up cash to service legacy debt. The lower prices fall, the more pressure they have to offload assets.
Once pricing improves, we start to see the cycle play out yet again. This is a pattern we’ve consistently seen for decades.
Kirkland Lake is a refreshing exception to the rule. For once, the industry has a management team willing to put shareholder wealth above a growth-at-all-costs mentality. It’s this mindset that could turn Kirkland Lake stock into a dividend all-star.
Ready for dividends
Kirkland Lake’s claim to fame is its focus on low-cost assets. This doesn’t sound groundbreaking, but it is.
As mentioned, when gold prices rise, previously undeveloped projects, which were deemed unprofitable, become profitable. The leverage on these mines can be incredible. When margins are slim, say $10 per ounce, it doesn’t take much upward movement in gold prices to double or triple profitability. If gold prices increase by just $100, the profitability of that mine might rise 10 times.
Lower cost projects don’t have this upside leverage. If the mine was turning a profit of $500 per ounce, and gold prices rose by $100, profits would rise by just 20%. That’s still impressive but nowhere near the upside of a thin-margin project.
Over the last five years, Kirkland Lake has pushed annual gold production from 314,000 ounces to nearly one million. Over that period, all-in costs fell from $916 per ounce to $584 per ounce. Costs are expected to continue falling with scale.
Notably, the massive capital expenditures needed to fuel this production growth are ramping down. High-profit production combined with low capital intensity should make Kirkland Lake a cash flow machine.
Free cash flow hit nearly $3 per share in 2019. This year, it could move even higher.
With a capital-focused management team, what will Kirkland Lake do with this excess money? Other gold miners would likely spend it on new growth opportunities. Given their past actions, however, it seems likely that this team will raise the dividend, redirecting funds directly to shareholders.
If Kirkland Lake paid out all of its 2019 free cash flow, the dividend yield would instantly go from 1.3% to 6.1%. Don’t expect that to happen overnight, but do expect a series of dividend raises in the quarters to come.
