TGR: Do you think the market will react to those cost numbers?
DM: We think the market will, particularly for Canadian producers, where 80–90% of costs can be in the local currency. This is especially true for more labor intensive underground operations like Kirkland Lake Gold or Lake Shore Gold Corp. For other non-U.S. based producers, a lower percentage of costs are in local currency, reducing the benefit of a strengthening U.S. dollar. For example, in Mexico or other Latin American countries, it could be 50–70% in the local currency, depending on underlying agreements and how developed mining is in that country. We expect the stocks to react as financial results are reported for Q1/15.
TGR: Are lower oil prices helping, too?
DM: Lower oil prices are certainly providing some benefit for all mining operations; however, large open-pit operations in remote locations are likely to see the largest impact on costs. With our coverage universe mostly consisting of underground operations, there is a reduced benefit. It is difficult to quantify the magnitude of the impact but it should provide a tailwind for most operations.
TGR: Tell us about some of the companies that you cover that continue to perform in a rather bearish market.
DM: One of our favorite names continues to be Klondex. It has two high-grade mines in Nevada. We like high grades in a volatile metal price environment because they provide protection for margins and can provide operating flexibility. With the company ramping up production and actively exploring at both assets, it is likely to have positive news flow throughout the balance of 2015 to support the stock.
TGR: Is the market giving Klondex sufficient recognition for both Midas and Fire Creek?
DM: Not yet, but the recent share price performance may suggest the market is starting to reflect the potential of both assets. Klondex recently published some drill results from Midas that continue to highlight the high-grade nature and longer life of that mine. Obviously, we continue to like Fire Creek; it has exceptional grades and has the potential for the mine-life to grow. We believe a portion of the discount that Klondex trades at relates to the fact that it is still at an early stage of production, as it has been in commercial production for just over one year. We believe the discount to peers is likely to decline as Klondex continues to execute at both operations.
TGR: Is Klondex starting to gain an institutional following?
DM: It is. We are starting to see a shift in the shareholder base toward institutions and not just traditional mining investors. Some generalists are starting to look at Klondex as a go-to gold name.
TGR: What are some other companies that are performing but still undervalued?
DM: In our view Kirkland Lake continues to be a high-potential name. Management is focused on generating cash-flow rather than simply producing ounces. The result has been improved profitability stemming from an increase in head grades and improved operating costs. One thing that stands out with Kirkland Lake is its guidance. When the company initially provided three year guidance in mid-2014, it did so at 15–20% below the planned reserve grade simply because the company had never previously delivered tons to the mill at the reserve grade.
However, for fiscal 2015, which ends April 30, the company has delivered almost 19% above guided head grades, approaching the reserve grade. We are now of the view that the guided head grades are likely going to increase for 2016 and 2017, and that the stock is going re-rate. As grade drives margins, with grades likely to improve, margins should also, so it's certainly going to provide additional free cash flow for a company that is already benefiting from a weak Canadian dollar.
TGR: CEO George Ogilvie cut 200 jobs from the Macassa mine complex and has put together at least three quarters of modest cash flow. What's his next challenge there?
DM: It's continuing to execute. The turnaround has been good so far, and the company has improved its grade and costs. The challenge now is sustaining the same trajectory that it has developed and continuing to improve beyond this initial stage.