Daniel Earle: “Lake Shore Gold a Missed Stock Opportunity”

Overview photo of the Bell Creek Mill, which was acquired by Lake Shore Gold in 2007.

On October 29th, Lake Shore Gold Corp. (TSX: LSG) reported their third-quarter financial results, boasting continued strong production and financial performance, with a 58 per cent increase in gold production and and a 15 per cent improvement in cash operating costs from the same period last year, among other highlights.

Lake Shore Gold’s CEO and President, Tony Makuch, commented in the company’s news release:

“Q3/14 is our fourth consecutive quarter of generating net free cash flow, a period during which our cash and bullion has increased by over $50 million. We have achieved solid production growth year over year, and are one of the lowest cost producers within our industry. Total cash costs per ounce sold were US$594 in Q3/14 and US$588 in 9M/14, while all-in sustaining costs averaged US$858 per ounce in Q3/14 and US$861 per ounce year to date.”

Several days prior to announcing their third-quarter operating performance, Lake Shore Gold was in the news with another company milestone – the successful results of its mineralization extension of 48 holes at its Timmins West Mine, which confirmed “… the presence of elevated gold values and [which] identified opportunities for extensions and new areas of gold mineralization [at the S2 Fold Nose in its Timmins West Mine].” Growing its resource base and extending its mine life is a critical focus for the company.

Taking a look at Lake Shore Gold’s performance over the past year, one can see that since mid-Q3 2013, the company, which is currently generating free cash flow and has been since Q4 2013, is making a strong case for sustained positive turnaround in operations.

As brief background, Lake Shore Gold is a major gold producer with exploration and development operations centred in the Timmins Gold Camp in northern Ontario, Canada.  The company owns and manages two operating mines – Timmins West and Bell Creek – and a central mill, the latter of which underwent a large expansion in October 2013.  The mill expansion ended up coming in at over 3,000 tpd, outpacing its nameplate capacity.

Lake Shore’s 50% throughput expansion completed in Q3 2013 can be seen as a genuine turning point in a company that’s historically been an underperformer, a point that’s allowed Lake Shore to generate strong free cash flow from Q4 2013 onward and that’s brought the company out of balance sheet issues.

The subject of Lake Shore’s balance sheet issues. 2013 also signaled the successful restructuring of $35mm in revolving debt, which Lake Shore is to re-pay to Sprott Resource Corp. (TSX: SCP.TO) by January 2015.  In December 2013, Lake Shore modified its lending agreement with Sprott Resource and was able to extend its $35mm in revolving credit to November 2016, a move that removed significant stress on Lake Shore stock.

At the end of December 2013, Lake Shore Gold successfully re-paid $5mm of its debt to Sprott Resource, reducing their owed principal to $30mm.  Following this, in June of this year, given Lake Shore’s strong operating results and growing free cash flow, the company announced that it had re-paid $10mm of its debt to Sprott Resource, reducing its principal owed to $20mm.

As mentioned, Lake Shore Gold has historically been considered an underperformer, with most analysts covering the stock rating Lake Shore Gold as a SELL.  More recently, in December 2013, given Lake Shore’s measurably improved operating performance and its signal of genuine turnaround in operations, one broker updated Lake Shore’s stock from SELL to HOLD.  As a sign of sustained and further improved operational output, in June 2014, two of the three banks covering Lake Shore revised their stock to HOLD, with one remaining at a SELL position.

Daniel Earle, who serves as Vice President and Director at TD Securities in Toronto, has provided in-depth analysis on the mining sector and precious metals for TD Securities since 2007, and has been a notable exception among the other analysts covering Lake Shore Gold.

Mr. Earle began covering Lake Shore Gold in August of 2008 and in June 2013, when the LSG stock hit a low of $0.16, Mr. Earle upgraded his recommendation of Lake Shore to a BUY, with a $0.70 target.

Since that time, Daniel Earle’s coverage has continued to be on key with the operational turnaround seen at Lake Shore Gold since the completion of its mill expansion in Q3 2013.

In August 13th, 2013, for example, Mr. Earle provided the following coverage for Lake Shore Gold:

“We believe the company is well positioned to achieve production guidance this year and together with a forecasted decline in capex over the second-half of the year, we believe sustainable free cash flow can be realized starting in Q4/13, marking a major turning point in the company’s history, in our view.”

On October 9th, 2013, Mr. Earle offered continued company coverage, stating:

“We would suggest that the company [Lake Shore Gold] has achieved an operational turnaround and that is a major breakthrough for the company.”

This was a prescient call, especially given that as of this quarter, with 9M 2014 production of 142.5 kozs and cash costs of US$588/oz (AISC of US$861/oz), Lake Shore Gold is on-track to beat its full year guidance of 160-180 kozs at US$675-US$775/oz (AISC of US$950-US$1050/oz).  Moreover, this year, Lake Shore increased its cash and bullion by approximately $14mm in Q3 2014 to $67mm ($62mm in cash and $5mm in bullion), while repaying approximately $4.1mm of debt to Sprott Resource in Q3 2014

Given Lake Shore Gold’s sustained improved performance output through to the third quarter of this year, Mr. Earle remains at a BUY for Lake Shore Gold, while some other brokers have stubbornly maintained their SELL ratings as the stock has more than quadrupled in value.

There is no doubt that the current depressed precious metals sector will play its role in how Lake Shore performs for the rest of the year and into Q1 2015.  However, the key point to consider is that Lake Shore’s recent exploration efforts have proven justified; moreover, the company operates on a free cash flow basis and remains able to aggressively re-pay its line of credit to Sprott Resource.  All this bodes well for the stock, and with continued strong performance from the company, Lake Shore Gold’s stock will increasingly prove an attractive buy opportunity.

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