A diamond is forever, or so the world was first told in 1947. The slogan - coined by the world's largest diamond producer, De Beers - might just be the most successful advertising campaign in history. But the precious gems industry is distinctly nervous about whether the tagline will continue to hold weight. That's because, unlike most things people dig out of the ground, diamonds - together with their producers and sellers - are entirely reliant on the whims of fashion.
In searching for a marketing strategy to support diamond buying for the next 70 years, miners are currently undergoing a period of what passes in the industry for soul-searching. Consumer habits, changing demographics and ideas about marriage have shifted since 1947, and will affect long-term demand trends. And yet, despite this risk, many major players are bullish on the future of diamonds and - by extension - their own prospects.
Value for mega miners
The clearest example of this is Anglo American (AAL) which, as the 85 per cent owner of De Beers, has long had a significant hand in controlling the diamond market. In February, the struggling miner launched a 'shrink to survive' strategy in a desperate attempt to reduce its $12.9bn (£8.9bn) debt pile. Coal, nickel and iron ore were all out, with copper and platinum group metals the only traded commodities left. The third pillar supporting Anglo's survival, chief executive Mark Cutifani had decided, would be made of diamonds.
A clear selling point of this strategy is that, unlike the wider Anglo American portfolio, the diamond division contains only world-class, long-life assets. De Beers, whose operations span Botswana, South Africa, Namibia and Canada, is responsible for the production of a third of the world's rough diamonds by value, and has long been a vital source of cash for Anglo. It is also wildly profitable. In the revised portfolio, diamonds are forecast to account for 42 per cent of cash profits, and would have increased the cash profit margin from 18 to 30 per cent in 2015 on a pro forma basis.
Fellow diversified miner Rio Tinto (RIO) may be better known for its (far more positive) exposure to iron ore and industrial metals, but it too sees hope in the diamond game. Rio holds controlling interests in two underground mines - Argyle in Western Australia and Diavik in Northwest Canada - and is currently developing a third at Bunder in the Indian state of Madhya Pradesh. The deposit, which was first discovered in 2004, is estimated to contain 34.2m carats within 53.7m tonnes of kimberlite and across eight diamondiferous pipes. Again, Rio views gemstones as a useful addition to its commodity-based portfolio, providing an uncorrelated income stream with a cash profit margin target of 42 per cent.
Burgeoning projects
Bunder, one of just a handful of projects in the global diamond pipeline, is set for a production ramp-up in 2017. Before then, Aim-traded Firestone Diamonds (FDI) should have finally started mining at its Liqhobong project, after years of weather-based setbacks and issues with its recovery plant (see below). The mine, which is 25 per cent-owned by the government of Lesotho, is expected to generate sales of $36.6m next year and $117.6m in FY2018, according to FinnCap analyst Martin Potts. An underlying profit margin above 50 per cent might seem overoptimistic, but Liqhobong is situated in the same mountain range as Gem Diamonds' (GEMD) Letšeng project, the highest average dollar per carat kimberlite diamond mine in the world.
Both Rio and Firestone will hope to replicate the success of Toronto-listed Lucara Diamond (TSE: LUC), which completed the construction of its Karowe mine in Botswana midway through 2012. The mine has been nothing short of a revelation, producing a stream of high-value large diamonds and leading to bumper cash flows.
This month, Lucara achieved the highest price ever for a rough diamond, when it sold an 813-carat Type IIa clear stone for $63m. This follows last year's discovery of the Lesedi La Rona, the first recovery of a carat gem quality stone larger than 1,000 carats for more than a century. These finds, and the prospect of further discoveries of large Type IIa stones has also done wonders for Lucara's share price, which has almost quadrupled since Karowe came online.
Supply and demand
What makes Lucara's story all the more rare is that there have been relatively few new significant diamond ore discoveries for decades. What's more, resource replenishment is on course to fall after 2025. Theoretically, these factors should be good for pricing, as demand has outpaced global GDP growth since 2009. However, this also assumes that future demand will naturally follow.
According to Jean Marc Lieberherr, chief executive of the Diamond Producers Association (DPA) - a sort of World Gold Council cum advertising agency for gemstone miners - there is some concern that demand could drop. According to a DPA survey carried out in the US, younger generations of consumers have a tendency to view diamonds as intimidating, tied to marriage rituals, and conventional rather than thoughtful. Consumption patterns increasingly prioritise experience over materialism, display an aversion to antiquated conventions, and seek "real connections in a sea of superficiality".
Next week, at the jewellery world's premiere event in Las Vegas, Mr Lieberherr will unveil the producers' solution to that marketing challenge. The hook for tomorrow's diamond buyer: "something that makes me smile, not something that makes others jealous." Whether that rings true with the target group remains to be seen, as does the DPA's assumption that younger people constitute a homogenous block from Los Angeles to Dubai, Shanghai and New Delhi. The lobby group, which represents 75 per cent of the world diamond production, will also be keen to minimise the competition from artificial gemstones, which have grown in popularity among consumers wanting cheaper and ethically-guaranteed alternatives to geological diamonds.
Favourites
We have warmed to the investment case for Gem Diamonds, although the company's at-times unpredictable sales performance has not always helped its shares. At 130p, the stock trades at a steep discount to the sector average, which seems unwarranted given Petra Diamonds' debt profile and thinner forward dividend yield.
Outside of London, we think investors tempted by the sector should also consider Lucara Diamond, given the sheer quality of its main asset at Karowe. The Toronto-listed company may be priced at an expectant four times book value, but the shares still trade at just 10 times consensus earnings, which is a discount to its key Canadian peers Dominion (CA:DDC), Mountain Province and Stornoway.
Outsiders
Anglo American might control the biggest name in diamonds, but the legacy issues that have dogged the mega miner's other divisions are a cause for concern. Specifically, we worry whether the market has the appetite for the $3bn-$4bn-worth of assets Anglo needs to sell this year. And while investors seem to believe in the shrinkage plan, the company's shares - which more than tripled in value between January and April - remain volatile.
Nevertheless, De Beers will be a superb core holding if Anglo can tackle its debt issues. That's despite a 10 per cent drop in first-quarter diamond production to 6.9m carats in 2016, an intentional attempt to stabilise global pricing, which dampened amid a contraction in demand from China, the Gulf and India last year.
The decision appears to be having the desired effect. Earlier this year, the group started publishing results of its sales in an effort to support a recovery in the market, and the drop in volumes appears to have helped value; this week De Beers reported $630m-worth of sales for its fourth cycle, which chief executive Philippe Mellier hailed as a sign of "continued stability of demand for rough diamonds".
