Join our community of smart investors

Cheap Gem Diamonds is a cut above

Gem Diamonds is the stand-out value play among the LSE's small-cap diamond traders.
December 11, 2014

The diamond operations of integrated miners such as Anglo America (AAL) and Rio Tinto (RIO) have been among their best performing assets over the past year or so. So it's curious that a relatively short time ago some of these assets were earmarked for disposal. The financial performance of diamond miners, together with a growing appetite for stones in the investment market, is forcing a reappraisal of the industry. There's now a handful of promising diamond plays on the LSE. And one such miner - Gem Diamonds (GEMD) - is undervalued across a range of measures, yet is on track to exceed guidance on both production and revenue per carat for 2014.

IC TIP: Buy at 176p
Tip style
Value
Risk rating
Medium
Timescale
Long Term
Bull points
  • Significant production expansion
  • High-grade output
  • Flexible marketing model
  • Maiden dividend expected
Bear points
  • Tender delay at Ghaghoo
  • Security concerns in Lesotho

Gem Diamonds has a 70 per cent stake in the Letseng diamond mine in Lesotho. The mine is renowned for large, high-quality diamonds, four of which are among the 20 largest rough white gem diamonds recovered since 2006. The company's output is marketed through a dedicated subsidiary based in Antwerp, which provides significant cost benefits and flexibility on pricing. Letseng's output attracted $2,747 per carat during the first half of this year, underscoring Letseng's status as the highest dollar-per-carat diamond mine in the world.

 

 

However, the principal lever of the share price in recent months has been the development of the Ghaghoo mine in Botswana. Although the mine is being brought into production within budget targets, the trajectory of Gem's share price will be determined to a large degree by the level of production that the phase one ramp-up at Ghaghoo will support. Gem's share price fell away in September when it emerged that water ingress had slowed down the initial production ramp-up at the mine. The company maintains that it is still on track to meet its annual ore throughput target of 0.72m tonnes in 2015, but the problems at Ghaghoo resulted in the first tender of its rough diamonds being delayed to the first quarter of next year. This resulted in a reduction in 2014 revenue forecasts, but it has also opened up a buying opportunity.

By the end of September, 4,028 carats had been recovered from Ghaghoo as it became operational, which includes a number of diamonds weighing in excess of 10 carats. Ghaghoo's potential importance is reflected by JPMorgan forecasts of a 2015 recovery rate of 160,000 carats, against Letseng's 112,000 carats. That said, Ghaghoo's revenue per carat is currently expected to be much lower at $279, although finding a few big stones could substantially increase the estimate.

Investors should also be aware of media reports relating to army activity in Maseru, Lesotho, although there has been no disruption at the company's Letseng mine which is situated some four hours from Maseru in the mountains.

Overall figures for the third quarter provide cause for optimism; quarterly production of 28,365 carats took the nine-month total to 83,043 carats, leaving Gem just 17,000 carats short of the upper end of its full-year guidance. Presumably, recent remedial work at both mines could push up unit costs, although the fact that Gem finds so many large stones tends to flatten out its cost profile.

 

GEM DIAMONDS (GEMD)
ORD PRICE:176pMARKET VALUE:£244m
TOUCH:176-177p12-MONTH HIGH:223pLOW: 137p
FORWARD DIVIDEND YIELD:1.5%FORWARD PE RATIO:9
NET ASSET VALUE:281¢NET CASH:$98.4m

Year to 31 DecTurnover ($m)Pre-tax profit ($m)Earnings per share (¢)Dividend per share (¢)
201130615344nil
20122023512nil
20132135815nil
2014*28191284.0
2015*351101304.0
% change+25+11+7-

*JPMorgan forecasts

Normal market size: 2,500

Matched bargain trading

Beta: 1

£1=$1.56