Kirkland Lake sells Macassa royalty to Franco-Nevada

VANCOUVER — Royalty and metal streaming agreements have risen to prominence over the past few years, and Ontario-based Kirkland Lake Gold (TSX: KGI; LON: KGI) opted to get in on the action on Oct. 29, when it inked a royalty agreement with big-time player Franco-Nevada (TSX: FNV; NYSE: FNV).

Under terms of the agreement Kirkland will sell a 2.5% net smelter return royalty (NSR) on its Macassa gold mine portfolio to Franco-Nevada for net proceeds of US$50 million. Kirkland maintains a three-year window to reclaim 1% of the NSR for US$36 million — less royalty proceeds that have been paid to Franco-Nevada prior to the date of the buy back. Meanwhile, Franco-Nevada has the option of receiving its NSR payments in either gold bullion or cash, and maintains a right of first refusal on any future royalty or stream interests from Kirkland’s properties.

Kirkland is in the midst of a US$95 million capital expenditure program aimed at bumping throughput at its Macassa complex to 2,200 tonnes per day. The company reported that roughly US$89.3 million of its expansion budget had been spent at the end of July, with the processing plant upgrade making up the largest segment of its remaining project capital.

Kirkland is aiming to bump its total gold sales to between 150,000 oz. and 180,000 oz. this year, which hinges on the successful completion of the company’s ramp up. Kirkland cranked out around 30,300 oz. of gold last quarter, though the company continued to struggle with high cash costs of roughly US$1,011 per oz.

Due to a number of planned shut downs related to the its Macassa upgrades, Kirkland reported a net loss of around US$800,000 last quarter, with cash flow from operations totalling US$14 million based on gold revenues of around $43.4 million. Capital expenditures for the period included US$13.6 million on infrastructure, US$10.6 million on property and equipment, and US$2.6 million on exploration. 

Kirkland has relied largely on its internal cash flow over the past few years, as well as US$121 million in convertible debenture financing. Falling gold prices have put a dent in that plan, however, especially when combined with lower-than-expected grades, and difficulties attracting the necessary mine workforce. The company reported cash and equivalents of $23.6 million at the end of July, which represents around a 50% year-on-year drop.

BMO Capital Markets analyst Brian Quast — who maintains a “market perform” rating on Kirkland — notes that BMO generally holds a negative view on royalty financing “given a one-time cash infusion is exchanged for an increase to operating costs in perpetuity.” According to Quast, the Franco-Nevada royalty carries roughly a 15% internal rate of return (IRR) at spot gold, which is “relatively high compared to recent royalty transactions.”

“Given no fixed obligation for repayment was disclosed, one could argue that a higher royalty IRR would still be reasonable relative to the company’s current cost of debt, which may be an indication of [Franco-Nevada’s] confidence in the mine’s future,” Quast wrote in an Oct. 29 research report, noting that the NSR will add around US$35 per oz. to operating costs at Macassa moving forward. “[Kirkland Lake] does have a buy-back option, and the risk of equity dilution has been removed in the medium term.”

And Kirkland has been able to maintain a relatively tight equity structure through capital programs at Macassa that have totalled US$286 million over the past four years. The company maintains 70 million shares outstanding and trades on average roughly 306,290 shares daily. Kirkland dropped around 6.6%, or 28¢, during the two days of trading following its royalty announcement, and closed at $3.96 per share at the time of writing for a $278 million market capitalization.