Finding a diamond-mining stock shouldn't be as tough as locating the actual minerals themselves. After all, we know where to look: The Toronto Stock Exchange provides four choices of a reasonable size, from established miners to companies emerging from startup mode.
Investor excitement, however, has pushed three of the names near their 52-week highs, despite a widespread belief that diamond prices will fall in the latter portion of this year. That leaves just one of the four seeming rather unpolished – but perhaps the gem of the group for value-oriented investors.
To get an overview of the industry, we turn to analyst Edward Sterck, who works in BMO Nesbitt Burns Inc.'s British affiliate. Mr. Sterck says that there's a general view that diamond supply will fail to meet demand in coming years based upon, as he cheekily says, "the large amount of effort put into exploration in the last 20 years or so, and the singular lack of success that has emerged through those efforts."
Some of the world's largest diamond mines, in Botswana, Russia and Canada, are getting older and harder to mine, and the newer projects are smaller. "There's nothing of a sufficient scale to replace declining production from elsewhere." Diamond supply peaked in 2007, he says, and "we're expecting it never to get back to the high-water mark."
At the same time, however, the market for diamonds can be erratic, as consumer demand for gems blows hot and cold with macroeconomic factors. The companies that cut and polish diamonds – diamantaires, as Mr. Sterck and others call them – often sell chunks of their inventory, pushing down prices, particularly when outside financing is a concern, as it has been in 2016.
"It's a very sentiment-driven market," Mr. Sterck says. "When diamond prices take a hit, diamantaires all think there must be something bad going on, so even if it's a diamantaire with perfectly good credit availability, they'll adjust their behaviour accordingly, thinking the market is perhaps in trouble. The same is true when pricing is up. It's an industry where you seem to have periodic price spikes followed by price collapses."
All of which makes it difficult for individual investors to navigate the individual diamond-mining stocks. But they certainly try, perhaps starting with the headline-grabbing Lucara Diamond Corp.
Lucara, you may recall, unearthed and put up for sale Lesedi La Rona, a 1,109-carat, tennis-ball-sized diamond – the second-largest uncut diamond ever discovered. (Trivia: The biggest was the Cullinan Diamond, found in 1905 in modern-day South Africa, which was more than 3,100 carats.)
Rather than market the diamond to the usual customers, however, Lucara chose a June public auction at Sotheby's in London – and then didn't sell it, as the $61-million (U.S.) high bid failed to meet the company's reserve price.
The shares dropped nearly 15 per cent on the news, and Lucara chief executive officer William Lamb tried to reassure shareholders that the company had a rock-solid balance sheet. To prove it, the company said it would distribute $172-million (Canadian), a significant chunk of the cash on its balance sheet, to shareholders in a special dividend. That helped the shares return to preauction levels.
Anyone who buys the stock by Sept. 2 will get the 45-cent dividend; at Friday's closing price of , that represents a yield. (Once the shares go ex-dividend, meaning a buyer is no longer eligible for the payout, expect there to be a sharp drop in the market price.)
All of this excitement means analysts are mixed on Lucara shares, despite their being cheap on a forward-earnings basis. Of the nine analysts covering the stock, five have "buy" ratings, while the other four have "hold" ratings.
Mr. Sterck notes the massive size of the diamonds Lucara has been pulling out of its Botswana mine and says, "If you look at next year's numbers and beyond, unless they can replicate that, it looks quite expensive." He has a $3.25 target price on the shares, implying a downside.
Des Kilalea and Richard Hatch of RBC Dominion Securities' British affiliate are more positive on Lucara, citing its strong cash flow, the potential sale of the Lesedi La Rona, and the potential for more dividends as reasons Lucara deserves a premium valuation – yet their target price is $4, with a "sector perform" rating, suggesting investors are getting ahead of the bullish analysts.
To find a mining stock less shiny, we turn to Dominion Diamond Corp., which has reported more bad news than good this year. The company owns a 40-per-cent stake in a mine operated by giant Rio Tinto, and wholly owns and operates its own Ekati mine in the Northwest Territories.
Sales were slow this year, Mr. Sterck says, meaning "the market has lost a little bit of faith in the company … and once the market loses faith in a company, it's hard to restore it." Worse, a June fire shut down Ekati, where Dominion had already delayed expansion plans. All of this has increased investor skepticism about the company's top "pipe" at Ekati, which Mr. Sterck notes is "prosaically" named "Misery."
This, actually, makes Dominion Mr. Sterck's top pick. "It looks very beaten up, [and] to be candid, the near-term catalysts are a little bit difficult to identify until the plant is back up and running," he says. "But the market cap for Dominion at the moment is $1-billion, they're sitting on about $350-million U.S. in cash, $200-odd-million in inventory, and I'm expecting them to generate more than $1-billion U.S. in net free cash flow over the next three to four years."
Of the seven analysts covering Dominion, five have "buy" ratings, with the remaining analysts at "hold."
For investors willing to take on more risk, there are two mining companies that are ramping up their new mines and getting into the sales business later this year. Mountain Province Diamonds Inc. has a joint venture with diamond giant De Beers to operate Gahcho Kue in the Northwest Territories. Stornoway Diamond Corp. is building the Renard mine in the James Bay region of north-central Quebec.
Both stocks are near their highs – despite the price of diamonds and without having made significant diamond sales – because of their "operational success," Mr. Sterck says. "Mountain Province and Stornoway have delivered their projects ahead of schedule, and Stornoway has delivered it under budget as well."
At the moment, analysts favour Stornoway, with six of seven tagging it with a "buy" rating, versus three of five analysts marking Mountain Province with a "buy." (The remainder, in both cases, have "holds.")
While Mr. Sterck has a "market perform" rating on Mountain Province, he accepts the high price of Stornoway because "they really have exceeded all expectations. They delivered first production five months ahead of schedule and $200-million under budget, which is pretty extraordinary. So there's the potential for them to translate that into operational success as the project ramps up. And the geological models suggest it could produce some really large, valuable diamonds as well."
The conclusion, after all this digging: Dominion is likely to shine for investors willing to buy down-on-their-luck stocks, while Stornoway may be the top choice for those willing to take on a company with a little less polish.