Petra, a diamond in the rough

Why would anyone buy a stock in this condition? We’ll be the first to voice misgivings about the outlook for the diamond market, but we think Petra’s current situation is a genuine, albeit very high-risk, value opportunity. This rests on one key assumption: that lenders will waive debt covenant breaches. The company has said it is “confident that the likely shortfall…will not present an issue”, while chief executive Johan Dippenaar has remained sanguine when we've quizzed him on the matter. Lenders would likely have already bailed out by now, and certainly not have agreed to a fresh $650m (£501m) bond issue as part of April’s capital restructuring.

If this judgement is accurate, then investors could see a sharp reversal in sentiment. Although the appreciation in the South African rand means on-mine cash costs are set to increase by around 12 per cent in the current year, so too is production, by as much as 25 per cent. This output is set to include an improved product mix, resulting in a higher value per carat. Capital expenditure is not expected to exceed $164m this year and $120m a year thereafter, meaning cash generation should finally start to step up. Analysts at Liberum, whose production forecasts are conservative, forecast free cash flow of $57m, $222m and $259m over the next three years. In theory, that should bring net debt down to $273m by June 2019, representing less than that year's forecast cash profits.

The brokerage has also drawn comparisons with the extraordinary turnaround seen at copper miner and long-term IC tip KAZ Minerals (KAZ), whose low-cost production ramp-up has been fortuitously timed to a swell in copper prices. While we are less confident of a similar price rebound for diamonds, Petra’s production expansion looks less onerous than it did for KAZ two years ago. The step up in grades, and increased share of undiluted ore, should also make up for any slip in costs.