Image: Haul trucks at Gem Diamonds' Letšeng mine in Lesotho, April 2014. Source: Gem Diamonds Ltd.
June 12, 2015
By Paul Zimnisky
Diamond miners are finally showing their potential as four companies in the highly concentrated industry have all announced first-time dividend programs within the last 12 months.
Despite a weaker diamond price in recent months due to tightened industry credit availability, a strong dollar, and a slowing of growth in Chinese luxury consumption, diamond miners have remained profitable.
Over the last year, four of out of five, or 80%, of the global universe of pure-play publicly traded diamond producers with market caps of at least $250 million were profitable; and all four have recently initiated first-ever dividend programs.
Russian-based ALROSA (RTS: ALRS) was the only unprofitable company in the universe due to a foreign exchange hit it took in 2014 on debt borrowed in U.S. dollars. The loss of 64 trillion rubles ($1.3 billion) came in the second half of the year as the ruble retreated to record lows versus the dollar.
The concurrent implementation of dividend programs across the industry could be seen as a fundamental shift in the investability of diamond miners, an industry that some would say has a reputation of failing to generate shareholder value. The diamond mining business is notoriously challenging given the high execution risk and capital-intensive nature.
In recent years the industry has benefited from improved operating efficiencies, which has led to more consistent cash flow generation. Most of the companies in the space are relatively new operators, having only commenced production within the last decade in the years following De Beers' restructuring. Experience gained by the new miners over that time has resulted in improved production and recovery techniques.
Image: 91.5 carat diamond recovered from Petra Diamonds' Cullinan mine in South Africa. Source: Petra Diamonds Ltd.
A stronger dollar has also benefited miners operating in Africa, Canada, and Russia, where labor and other operating costs paid in local currencies have become less expensive relative to the price of diamonds sold by the companies in U.S. dollars.
While improved operating economics has provided the companies with the means necessary to return cash to shareholders, the advent of dividend programs is impart due to a fundamental shift that has taken place in the mining industry as a whole (not just those producing diamonds), geared more towards returning cash to investors than accumulating resource inventory.
In the second half of last decade, in the midst of the commodity “super-cycle”, the global investment community incentivized mining executives to accumulate and hoard reserves, even if through expensive acquisition, as investors valued mining companies on resources and reserves held in the ground, and not so much on production cash flow and profitability.
The global financial crisis rendered many of these expensively acquired reserves uneconomic, which led to record-setting write-down’s in the mining industry over the last 6 years. Global investors have since begun valuing mining companies using more traditional profitability metrics, putting pressure on mining executives to shift focus to production efficiencies and cash flow generation.
In June of last year Canadian-listed Lucara Diamond Corp (TSX: LUC) was the first stand-alone diamond miner to commence a dividend program, which yielded 1.7% at the time, or 3.5% including the “exceptional diamond” special dividend that was also paid. Since then, Dominion Diamond Corp (TSX: DDC), Gem Diamonds Ltd (LSE: GEMD) and Petra Diamonds Ltd (LSE: PDL) have all announced dividend programs. ALROSA was paying a dividend prior to going public in October 2013, and continues to do so despite the FX loss realized in 2014.
De Beers, a subsidiary of larger diversified miner Anglo American (LSE: AAL), is not included in the universe of stand-alone diamond miners, however De Beers' recent performance relative to Anglo’s other divisions is consistent with the rest of the players in the space. In Calendar 2014, Anglo’s company-wide EBIT (earnings before interest and tax) decreased 25.5% year-over-year, while De Beers’ EBIT actually increased 39.5%; the De Beers unit represents 24.8% of Anglo’s total assets.
Using the universe of stand-alone diamond miners as a market proxy values De Beers at around $7.3B. If Anglo were to spin out the division, it’s not unreasonable to assume that the market would also pay a pure-play premium for the industry leader.
At the time of writing Paul Zimnisky held a long position in publicly traded diamond explorer North Arrow Minerals, but did not hold a position in any of the companies mentioned in this article.