Tough year tests Dominion

It’s been a turbulent year for Dominion Diamond (TSX: DDC; NYSE: DDC).

2015 was always expected to be a transitional year for the miner: At its 88.9%-owned Ekati mine, the company knew it would be mining lower-grade ore before starting to mine the extremely rich Misery Main pipe in 2016 (Dominion’s fiscal 2017).

But a slide in diamond prices combined with lower-than-expected quality diamond production from the Misery Southwest Extension at Ekati, and demands by activist shareholders near the end of the year all ramped up the challenges for the miner.

The company reported a net loss of US$34.9 million or 41¢ per share in its fiscal fourth quarter, ended Jan. 31, 2016, compared with a loss of US$2.2 million in the same quarter a year earlier.

Part of the wider loss was due to rough diamond prices. For the year, prices were down 10% for Dominion — in the fourth quarter alone, they dropped by 5%.

Adding to the loss was a US$19.8 million inventory impairment recorded on “work in progress” inventory at Ekati, due to lower than expected quality of material being mined from Misery Southwest. Estimated prices for goods from the Misery Southwest Extension were lowered to US$40-55 per carat from a modeled price of US$70.

“Approximately 60% of the carats we recovered in the fourth quarter were low-value material from Misery Satellites and coarse ore rejects, both of which are non-reserve material,” said CEO Brendan Bell in a conference call. “Following the single-sourced sampling of Misery Southwest material in October, we confirmed that Misery Southwest diamonds were of lower value than originally modeled.” Efforts to increase diamond liberation at the Ekati plant – although successful — also slowed throughput. Processing volumes were 12% lower than the previous year, with throughput decreasing to 10,500 tonnes per day from 12,000.

Dominion’s 40%-owned Diavik mine also saw reduced production. In 2015, production was 9% lower than planned at 6.4 million carats due to a combination of lower mining rates from the A-154 North kimberlite, lower grades from A-418, and availability of the process plant in the fourth quarter. Operator Rio Tinto (NYSE: RIO; LSE: RIO) owns 60% of the mine.

Despite the operational and market challenges, Dominion still generated positive free cash flow of US$27.5 million for the fourth quarter. It spent US$56.1 million on the Misery Main, Sable and Pigeon pipes, the Jay feasibility and the development of the A21 pipe at the Diavik mine against strong operating cash flow of $83.6 million.

Activist challenge

But as rough diamond prices sank in 2015 — by about 12-15%, according to BMO Capital Markets — so did Dominion’s share price. From a high of nearly $24 mid-year, the stock sunk to as low as $10.50 in November.

Late last year, a group of activist investors holding 5.4% of Dominion’s stock complained that the miner’s shares were undervalued and that management was not doing enough
to address issues around project priorities, capital allocation, diamond marketing and corporate governance.

Soon after, Dominion came to an agreement with the group, appointing former De Beers Canada CEO, and more recently co-president of Barrick Gold, Jim Gowans as chairman in April. Gowans replaced company cofounder, ex-CEO and Dominion chairman for 12 years, Bob Gannicott. Gannicott, who was on medical leave during much of 2015, will remain a director. The company also appointed investment fund portfolio manager Josef Vejvoda to the board.

Meanwhile, two Dominion directors also resigned in December.

The turbulence at Dominion appears to be over — at presstime, its shares were back up near $16. The diamond market also started to pick up in the first quarter, Jim Pounds, executive vice-president, noted in a conference call in April.

However, Dominion is still in the middle of a strategic review announced in late December.

The company hired an investment firm to help it maximize shareholder value. CEO Brendan Bell says Dominion will provide more information on the review at the end of May, when it expects to release a feasibility study on Jay.

The company has also confirmed that it’s doing optimization work to lower costs at Jay.

A prefeasibility released in January 2015 pegged initial development capital for the project at US$657 million. Over an 11-year mine life, the study projected Jay’s post-tax net present value at US$610 million and its post-tax internal rate of return of 16%, using a real discount rate of 7%.

While diamond prices have declined since the Jay study was compiled, pricing in Canadian dollars has actually remained at comparable levels because of the decline in the Canadian dollar.

Jay is currently in the permitting stage with a decision by the Northwest Territories’ Minister of Lands expected in May. The Mackenzie Valley Environmental Impact Review Board has recommended development be approved, subject to 22 measures. Dominion believes it can meet the conditions without compromising the project’s economics.

Misery Main

Operationally, the company will continue to invest this year, but will see a big increase in cash flow from Misery Main. First ore at Misery Main was mined in the fourth quarter, with revenues from the pipe expected to flow starting in the second half of 2016.

While Misery Main diamonds are not particularly high value at US$75 per carat, Dominion expects to be able to pay for the development of Jay with cash flow from the pipe because of its exceptionally high grade of 4.7 carats per tonne. It is also expecting partners at Jay (including Archon Minerals) to contribute their share. Dominion owns 65.3% of Jay.

In addition to advancing Jay, Dominion will spend $55 million this year on development at Sable, where first production is expected in fiscal 2019.

The pipe, which has a 10-year mine life, is part of the Core Zone at Ekati, in which Dominion holds an 88.9% interest.

A prefeasibility study for the project, released in February, projects 10.1 million carats could be recovered at Sable from ore grading 0.8 carat per tonne at an initial capital cost of US$142 million. Prestripping capital was estimated at US$85 million and sustaining capital at US$19 million. The study, which used a base-case diamond price of US$140 per carat estimates the project’s post-tax, incremental net present value at US$137 million and a post-tax internal rate of return (using a discount rate of 7%) of 16.2%.

Dominion has a strong balance sheet to support its development ambitions: At the end of January, the company had unrestricted cash and equivalents of $320 million, restricted cash of $63.3 million, and available credit of $210 million.

Rio Tinto and Dominion recently doubled probable reserves at the A-154 North kimberlite at the Diavik mine to 4.7 million tons containing 11.1 million carats. A new mine plan will follow.

In 2016, Dominion expects production at Ekati of 3.7 million carats and Diavik production (on 100% basis) 7 million carats.

Dominion is also investing in exploration, CEO Brendan Bell recently noted.

“From a growth perspective, we have adopted a twin-track approach to building our future,” he explained in a conference call. “Alongside construction of Sable and the advanced valuation of Jay, we have started earlier-stage work on the existing portfolio of kimberlites on the Ekati property and nearby.”

The miner is investing $1.3 million in early stage exploration at its Lac de Gras joint venture with North Arrow Minerals (TSXV: NAR). Analysis of till sample results from a 2013 program in conjunction with historic data suggests there are three strong regional KIM trains on the property, plus local trains and other anomalies to investigate

Dominion is also evaluating several undeveloped kimberlites on the Ekati property for further drilling in 2017.