Investors in the gold (GLD) trade just endured one of their worst months in years for the more volatile Gold Miners Index (GDX), with the ETF plunging by 13.8% in June, its worst performance since 2016. While this sharp correction in the ETF led to a loss of momentum for the bulls and has led to a few 52-week lows across the sector, it has also opened up a new buying opportunity for investors. This is because many mid-cap gold producers are now sporting double-digit free cash flow yields, and some are paying dividends as high as 2.0%. In the previous decade, it’s been hard to a 1.0% dividend yield in the sector that looked secure. However, we’ve seen a change of character in this cycle, with multiple dividend raises, while maintaining low payout ratios and still spending heavily on exploration & growth. This suggests that investors in the sector should enjoy significant value being returned to shareholders over the next three years as long as the gold price remains above $1,650/oz, with room for buybacks, additional raises, and growth financed without any dilution. Let’s take a look at a few of the better names worth putting on one’s shopping list:

(Source: Author’s Chart)

Kirkland Lake Gold (KL), Gold Fields (GFI), and Iamgold (IAG) have all been punished by the market over the past several weeks. The sharp correction has been spurred by downgrades to earnings estimates as the gold price has tumbled lower, with the average realized gold price in 2021 likely to average below $1,900/oz given its volatile H1 performance. While this might appear disappointing to most investors, it’s important to note that most miners reported an average sales price of $1,770/oz in 2020, and most are enjoying 40% plus margins at current prices. This suggests that while the correction has weighed on margins, these miners are still in one of the best price environments in history. Despite this, they’re valued synonymously with a commodity trading in a bear market. Let’s take a closer look below:

Beginning with Gold Fields, the company is one of the better organic growth stories in the sector and is working to bring its Salares Norte Project online in H2 2023. This massive Chilean mine can increase production by more than 20% at industry-leading costs below $700/oz and could help push annual EPS above $1.45 in FY2024 once fully ramped up. Based on expectations, this should push annual output to 2.7 million gold-equivalent ounces, translating to more than $4.5 billion in revenue at current gold prices.

(Source: Company Filings, Author’s Chart)

If we look at the company’s earnings trend below, we can see that GFI had an incredible year in FY2020, reporting annual EPS growth of more than 300%, with annual EPS soaring to $0.86. While annual EPS estimates are for $1.12 (down from $1.30) due to softer gold prices, this still leaves GFI very reasonably valued at a price of just $9.15 per share. So, while the earnings revisions certainly aren’t bullish, the stock likely overreacted to the downgrades with it priced at less than 10x earnings. Looking ahead to FY2024, GFI should be able to generate a minimum of $1.45 in annual EPS with a gold price of $1,800/oz, translating to significant upside potential. Even if we assume an earnings multiple of 11, this translates to a fair value of $15.95, material upside for a 2-year target price. So, while traders have dumped the stock anticipating a softer year ahead after downgrades, I see the stock as a steal at $9.00 per share. Notably, the stock also pays a more than 2.75% yield, with investors being paid to wait for the next phase of growth.

(Source: YCharts.com, Author’s Chart)

The next name worth adding to one’s shopping list is Kirkland Lake Gold, one of only two million-ounce gold producers operating out of strictly Tier-1 rated jurisdictions. Not only does the company have the least risk among its peers, but it also has the best margins, with all-in sustaining costs estimated to come in below $820/oz this year despite the recent strength in the Canadian Dollar. This should translate to all-in sustaining cost margins of more than $950/oz in FY2021 and the ability to generate annual cash flow of more than $800MM. After the stock’s recent correction below $38.50, KL is now valued at an enterprise value of barely $9.2BB, leaving the stock trading at a roughly ~9% free cash flow yield, which assumes a gold price of less than $1,950/oz this year. If we see upside in gold prices, the free cash flow yield should improve to double-digit levels.

(Source: Company Filings, Author’s Chart)

While there are other names out there with double-digit free cash flow yields in the market, it’s hard to find any with 40% plus gross margins, no debt, roughly $1BB in cash, and a massive buyback program. Assuming KL decides to continue buying back shares, the company should be able to generate $3.70 in annual EPS in FY2022, leaving the stock trading at roughly 10x earnings. Prior to its acquisition which placed it in the penalty box, the stock rarely traded below 20x earnings, let alone 10x earnings, suggesting that the stock remains significantly undervalued at current levels. Even assuming a conservative earnings multiple of 15 and annual EPS estimates of $4.00 in FY2023, I see a fair value of $60.00, or nearly 60% upside from current levels.

Finally, Iamgold is the highest risk name on the list by far, but it does offer the most upside if the company can execute successfully. Iamgold has been a massive underperformer for years with seismicity issues at its Westwood Mine in Canada and production missed at its Saramacca and Essakane mines. The company’s Q1 report wasn’t much better. This is because there was no underground production from Westwood while the company aims to bring it online safely in H2 and heavy rainfall at Saramacca weighed on production in Suriname. These headwinds led to a ~20% decrease in production from Q1 2019 levels, with the company now unlikely to meet guidance. Combined with gold price weakness, this has led to a more than 20% decrease in the share price, with IAG sitting at $2.90 per share.

(Source: Company Filings, Author’s Chart)

While the investment thesis is satisfactory at best with the current production profile, Iamgold is busy building a massive mine in Ontario, with a 65% interest in Cote Lake. This mine is expected to produce more than 490,000 ounces per year for its first five years (2024-2028), translating to more than 320,000 ounces of gold production attributable to Iamgold. This would translate to 47% production growth relative to my projected FY2022 guidance of 675,000 ounces, and costs at Cote Lake are expected to come in below $800/oz. Assuming a successful ramp-up, this would transition IAG from a high-cost miner to an average cost miner while adding $500MM per year in revenue from Cote Lake alone.

(Source: YCharts.com, Author’s Chart)

As shown above, IAG trades at more than 13x FY2021 earnings estimates, and this is quite expensive for a consistently underperforming miner with most of its production from Tier-3 jurisdictions. However, annual EPS should nearly double between now and FY2023 with the addition of Cote Lake, with a significant portion of high margin production added to the company’s production profile. If we assume $0.36 in annual EPS for FY2023 and a multiple of 12, this translates to an 18-month target price of $4.32, with further upside once Cote Lake is fully ramped up in 2024. As noted, this is contingent on solid execution and the mine performing as planned, but at current levels, Iamgold looks very reasonably valued if Cote Lake comes online on time and on budget.

While it’s easy to be pessimistic about the Gold Miners Index with its weak year-to-date performance, the sector is arguably one of the few where companies are available at double-digit free cash flow yields. If we combine this with the fact that many of these companies are paying dividend yields above 1.90% at current prices, the sector offers a rare mix of growth and value at current levels. So, for investors looking to diversify, KL and GFI look like two solid ideas in the space to buy on dips. For a more medium-risk, high-reward proposition, IAG would move onto a Strong Buy rating below $2.70.

Disclosure: I am long GLD, KL

Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

KL shares were trading at $38.79 per share on Friday afternoon, up $0.41 (+1.07%). Year-to-date, KL has declined -6.01%, versus a 16.42% rise in the benchmark S&P 500 index during the same period.

About the Author: Taylor Dart

Taylor has over a decade of investing experience, with a special focus on the precious metals sector. In addition to working with ETFDailyNews, he is a prominent writer on Seeking Alpha. Learn more about Taylor’s background, along with links to his most recent articles. More...

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