Successful investing is based on buying low and selling high, as the adage goes. The diamond market is at a low point and listed miners are suffering: shares in the seven larger public diamond miners on the Toronto and London stock exchanges are down between 40 and 88 per cent on a year ago, and Stornoway Diamond Co has handed its Renard mine in Quebec to creditors after only two years of operation.
It has been a perfect storm on the supply side – an industry focused on maintaining the image of diamonds as rare and difficult to find (see the Diamond Producers Associations' campaign tagline: “Three billion years in the making”) is awash with stones and the whole supply chain squeezed. Margins collapsed in such a significant way that Anglo American (AAL) subsidiary De Beers’ buyers (sightholders) asked for relief from the system of buying packages of stones at auction every month or so. It’s not surprising De Beers has taken the step, with cycle 8 (the eighth auction of the year) seeing a 39 per cent drop year on year in revenue, to $295m (£229m).
It’s not a large sector, either, like oil or gold, in which low prices will hurt just the weakest. According to De Beers’ numbers, just nine mining companies contributed 73 per cent of global diamond supply in 2018. Take away the Anglo American subsidiary and Russian producer Alrosa, and that becomes seven listed miners fighting for an eighth of the market.
When broken down like this, it’s not a surprise diamond miners are in dire straights. Petra Diamonds (PDL), Gem Diamonds (GEMD), Firestone Diamonds, (AIM:FDI) Lucara Diamond (TSX:LUC) and Mountain Province (TSX:MPVD) have all seen their valuations plunge in the past 12 months. Of that group, Firestone takes top spot with an 88 per cent fall to 52p, with Petra close behind after falling 81 per cent on a year ago, to 8p. The Cullinan owner’s market capitalisation got close to £1bn in 2014, but is now below £100m.
Their cohort, according to the De Beers Diamond Insight Report released in October, also includes Rio Tinto (RIO) and Stornoway Diamond Corp, but Rio is insulated from the slowdown as a diversified major and Stornoway has been delisted and its mine handed to creditors. By contrast, Alrosa is down 27 per cent year on year on the Moscow stock exchange.
Shattered stones
With hindsight, the biggest winners in the industry in recent years were the Dominion Diamond Mines' shareholders who voted for a cash takeover in 2017 and walked away with $14.25 per share. There is little chance of that for those holding diamond miners that are still listed, so the big question is whether a recovery is possible. Industry leaders describe the current situation as simple oversupply – Stuart Brown, chief executive of Canadian diamond miner Mountain Province, told us it was “indigestion” caused by new mines. But the situation has been aggravated by demand factors. Independent diamond industry analyst Paul Zimnisky said recent challenges on the demand side included the Hong Kong protests, which hit retail sales and industry trade, weaker buying habits in Europe and a strong US dollar. He also highlighted the trade war between the two largest diamond markets, the US and China, as a potential disincentive for buyers to splash their cash on jewellery. Mr Brown said recent months had not been easy. “The second half of the year has been much tougher than the first half of the year, but we're starting to see demand pick up for certain categories as we come into the main manufacturing season,” he said.
The price collapse has also come at a time of industry change – in the past two years, new chief executives have come in at Lucara, Petra Diamonds and Mountain Province as the old guard of William Lamb, Johan Dippenaar and Patrick Evans took their leave. The new bosses were quickly thrust into a falling price environment and an oversupply scenario.
Petra chief executive Richard Duffy, a newcomer to the diamond industry, said veterans had told him turnarounds were quick but was hopeful of an immediate return to higher prices. "In the short term it will continue to be fairly difficult, although we're seeing some early indicators of stabilisation and modest improvement,” he said. Petra saw its average per-carat sales price fall over 20 per cent year on year during the three months to September, to $81. Mr Duffy said the moves at the big end of the industry would rev-up prices eventually, but it would take time for supply cuts to travel down the supply chain.
“There is still some surplus on the polished end of the pipeline,” he said. “But we're seeing some tightening in the pipeline and some balance being restored.” Mid-cap diamond bosses can cross their fingers and hope supply cuts make a difference. Rio Tinto has formerly been a major player because of its Argyle mine in Australia, but this has been slowing down as the reserve dwindles. The industry’s hope is the mine’s shutdown in 2020 will cut supply enough to boost prices further. According to Petra’s numbers, global production is forecast to fall from 150m carats (mct) a year in 2018 to 115mct a year by 2030.
One of the newer mines contributing to the supply glut is the Gahcho Kué mine in Canada’s Northwest Territories. Mountain Province – whose shares are down 41 per cent in the past year – has managed to keep its earnings fairly stable despite prices falling. The company owns 49 per cent of the mine alongside De Beers as operator and 51 per cent owner. Mr Brown told us the signs were not looking good in 2018 and the join-venture partners hoped they could attempt to up the processing grade at the operation to maintain earnings.
“A year ago when we were engaging with De Beers, together we looked at... what would we do if life got worse,” he said. Difficult weather hit the September quarter mine performance but the previous three months show the plan in action – 1.08mct of diamonds were sold at $67/ct, compared with 1.11mct sold at $69/ct the year before, when prices were much stronger. This is still a decrease, but adjusted cash profits were maintained at $29.7m for the three months to 30 June, compared with $31.3m the year before. “Had we not done all the modifications and the hard work and the changes we would have been in a much worse position to where we are right now, given the way the market's performed,” Mr Brown said.
Bigger is better
The low prices are largely for the smaller stone market – around three-quarters of a carat upwards, but these are the vast majority of production for diamond mines. The risk and reward for these miners comes from finding big stones: a single diamond can flip a quarter's trading into profit. Petra and Lucara have done well out of their big stone finds in recent years – most notably the latter company’s 1,109ct Lesedi La Rona, which sold for $53m in 2017. Lucara found seven diamonds greater than 100ct in the September quarter, compared with 10 in the June quarter and seven again in the first three months of 2019. These finds did not keep it in the black in the third quarter, however.
Gem Diamonds, which has the Letšeng mine in Lesotho, has found 10-15 100ct-plus diamonds a year traditionally. Its per-carat revenue in the September quarter was $1,417/ct, compared with Mountain Province and Petra below $100/ct. On the surface, Gem’s September quarter sales suggest large stones have maintained their value, with five diamonds sold for over $1m each, but the $1,417/ct figure is 12 per cent down on the year-to-date average. Chief executive Clifford Elphick said the large stone market had also “experienced price pressure” during the period. Gem has still done better than most other diamond equities however, falling 39 per cent in the last 12 months.
Petra is no stranger to big finds – this year it recovered a $15m, 425ct stone at Cullinan, but this was not enough to excite investors. Therein lies the promise of the diamond market – a quarter can be turned around with a big find, but the backbone of the industry is the small stones that come from run-of-mine production at the major operations.
