Should this Diamond be Cut or Polished?
“…if the Diamond market continues to recover Petra’s share price doesn’t have to pick up by much to offer potential gains for bold investors…”
Battered by a financial restructuring that has left shareholders with less than 10pc of the company, high-profile allegations of shootings by security guards, and the Covid-induced closure of one of its mines, once high-flying miner Petra Diamonds (LON:PDL) has been brought crashing to earth over the past few years.
Petra’s strategy during the good times was to pick up proven assets that, though past their prime, offered the prospect of several years worth of robust production through the application of modern mining techniques. The company has compiled a select set of some of the industry’s most best known mines, the Cullinan, Finsch and Koffiefontein underground mines in South Africa, and Williamson, an open pit mine in Tanzania, that together give Petra one of the world’s largest diamond resources, with a resource base of circa 243 million carats (Mcts) and reserves of 38.86 Mcts (as at 30 June 2020). The company expects contemporary drilling technology will extend the longevity of each site beyond its projected 2030 life of mine date.
The venerable Cullinan mine, which has a resource of 152.50 Mcts, is renowned for having produced several legendary diamonds, including the largest ever found, a 3,106 carat diamond mined in 1905 that was divided to form the two most prominent diamonds set into the British Crown Jewels. Cullinan is also notable for producing very rare blue diamonds that – created at depths more than 500 kilometres below the Earth’s surface – are perhaps the deepest-formed diamonds ever mined.
Finsch, South Africa’s second largest diamond mine, with resources of 39.1 Mcts, produces a steady supply of commercial five carat stones and gem quality smaller diamonds, and occasional larger stones of more than 50 carats. Koffiefontein, first mined more than 140 years ago, has resources of 5.31 Mcts, and produces high quality white stones of between five and 30 carats, and the occasional pink diamond. Williamson, a 38 Mcts resource operated by Williamson Diamonds Limited, and 25pc owned by the government of Tanzania is known for its rounded white and pink diamonds.
Petra’s annus horribilis
Petra’s bold acquisition strategy helped it become the world’s fourth largest diamond company during the mining boom of the first decade of the 2000s. But the burden of debt incurred during those years of expansion, including investment in a new processing plant at Cullinan and the expansion of underground operations at other mines, began to weigh heavily when a supply glut in the diamond market started to push prices down.
Petra’s vulnerabilities were exposed in 2019, when diamond prices plummeted to multi-year lows, production difficulties at Williamson, Finsch and Cullinan pushed revenue down by 23pc, and an an interest payment on a $650m bond began to loom on the horizon. The company lurched into crisis when the pandemic slashed demand for diamonds in an already oversupplied market, forced the closure of retailers, put cutting and polishing centres in India into lockdown, and restricted access to mines.
Petra put its Williamson mine on care and maintenance in April, and suspended its sales events a couple of months later. As revenues fell to a nine-year low Petra briefly sought buyers for all or part of the company when it became clear it could not meet the interest due on the $650m bond, before agreeing a deal with bondholders in October to halve its debt load. The restructuring committed Petra to convert $337m of the $650m in bonds due in May 2022 into new five-year bonds, and the remaining debt into equity, leaving shareholders with a 9pc holding.
In the midst of the painful financial re-engineering process Petra was hit by a claim filed at the High Court in London by UK law firm Leigh Day on behalf of 35 people – subsequently expanded to 72 – alleging ‘serious human rights abuses’ by security guards at the Williamson mine. The claim brought against Petra and mine operator Williamson Diamonds Limited alleged guards had caused multiple deaths and injuries amongst locals by shooting and beatings. Leigh Day’s action was supplemented by further evidence by the NGO Rights and Accountability In Development (RAID).
Petra formed a Board Sub-Committee comprised of independent Non-executive Directors and a specialist external investigator to examine the allegations which reported this May, the Sub-Committee finding ‘that past incidents have taken place that regrettably resulted in the loss of life, injury and the mistreatment of illegal diggers, within the Williamson Diamonds Limited Special Mining Licence area’, and that the incidents involved the operator’s ‘third-party security provider … as well as the Tanzanian Police Force.’ No evidence emerged ‘that Williamson Diamonds Limited personnel were directly involved in these actions.’ The parties reached a settlement, on a no admission of liability basis, encompassing the payment of of £4.3m and the appointment of a new third party security contractor.
Humbled by the reputational damage inflicted by the allegations, and radical financial restructuring, Petra has had little option but to sit tight, run a tight ship, and hope for an upturn in diamond market. And as the wider commodities market has surged since the turn of the year the market has indeed flickered back in to life.
Diamond jewellery sales in the US, the world’s largest market, were 30pc up through March to May as compared to the same period in 2019, and prices for rough diamonds were up 14.5pc of mid-June, helped by the world’s largest diamond miners cutting supply by around a fifth to pre-Covid levels in order to support prices. Anglo American, which owns De Beers, has reported ‘strong demand for rough diamonds’ from cutting and polishing centres, and has sold $470m at its diamond auctions, as compared to $391m two years ago.
The upturn helped Petra turn in unspectacular but – in the reasonable assessment of CEO Richard Duffy – ‘credible results’ in its trading update for the year ended 30 June 2021. Production was down year on year 10pc to 3,240,312 carats (2020: 3,589,176 carats), with production at both Finsch and Koffiefontein hit by the high level of rainfall, and the closure of the Williamson mine. But Cullinan recorded a record annual production of 1.94 Mcts, and Petra’s parlous balance sheet was strengthened somewhat by a 38pc increase in revenue to $406.9m (2020: $295.8m). The company reported cash of $156.9m (2020: $67.6m) and, following the restructuring, the reduction of debt by two thirds to $241.2m at 30 June 2021 from $700.4m at 31 December 2020. An ongoing organisational review is seeking to cut costs by $20m each year.
Petra said its revenues were boosted by higher demand for rough diamonds in the key US and China retail markets, and by diamond prices that rose 5.7pc in Q4 2021 from the previous quarter. The company’s income was also charged by its ‘best ever year’ for the sale of of ‘exceptional stones’, which contributed $60.2m (2020: $14.9m). That figure does not include a further $40m – due to show up in future accounts – from the sale of a 39.34 carat Type IIb blue diamond recovered at Cullinan in April, the biggest sum Petra has ever received for the sale of a single stone. Last month Cullinan yielded another spectacular stone a 342.92 carat Type IIa white diamond to be tendered for sale in September.
Petra expects robust demand for its rough diamonds over the second half of the year, and there are indeed promising signs that the market is set to enjoy a positive run. Increased sales by luxury good companies such as LVMH and Watches of Switzerland indicate consumers are switching from ‘experiential luxury’ spending on intangibles like holidays to to ‘material luxury’ spending. Demand seems to be catching up with supply, De Beers reporting that ‘strong demand’ for rough diamonds has pushed up prices by 13pc year on year to $135 a carat. Last month US and China retailers achieved 5-10pc and 15-20pc rises respectively in the fourth quarter compared with the same period in 2019. The Natural Diamond Council, representing seven of the largest diamond producers, has launched a major marketing campaign to attract a new generation of consumers to $80bn diamond industry, seeking to disentangle diamonds from their traditional association with love and marriage, and present them as a more ‘casual’ everyday purchase.
Even by the standards of the notoriously volatile diamond market Petra’s share price has deteriorated spectacularly over the past few years, declining from a high of 168p in the summer of 2014 to just under 65p in early 2018, to 10.7p going into 2020, and all the way down to 1.7p at the time of writing. But it has been a jagged decline with significant upward spikes. As noted, Petra is flat on its back, rather helplessly dependent on the state of the diamond market. And as that market has recovered somewhat the company’s shares have begun to creep up, rising by more than 5pc over the past month.
Petra’s micro recovery is taking place in the shadow of a restructuring that handed debtors 91pc of the company through a debt-to-equity conversion. And there must be real doubts as to whether Petra’s assets, proven as they are, are strong enough to ever pull the company out of a still substantial $241.2m debt. But if the diamond market continues to recover Petra’s share price doesn’t have to pick up by much to offer potential gains for bold investors with the discipline to restrict their exposure.