Diavik diamonds ‘highly desirable in US market’: analyst

60 Minutes rarely misses the mark when it comes to the quality of its investigative journalism. Unfortunately, a recent segment on the diamond industry failed to give much credit to global efforts to stem the influx of conflict diamonds from strife-torn regions such as Sierra Leone.

Indeed, the segment perpetuated the myth that almost all diamonds produced in the world are marketed through a cartel controlled by De Beers, and that they would be worthless without such a cartel. It left the impression that buying diamonds could lead to an increase in the number of atrocities being committed by rebels fighting to control diamond-producing areas in Africa. Sadly, the program never mentioned the emerging Canadian diamond mining industry at all, or gave more than a passing reference to other nations that are enjoying prosperity because of diamond mining.

Even so, consumers can’t be faulted for wanting to know where and how their diamonds are produced. Indeed, Canadian producers have already implemented programs that give consumers such assurances. Analysts are also mindful of societal expectations when they review and assess diamond companies.

Kerry Smith, analyst for Haywood Securities, recently issued a “buy” recommendation for Aber Diamond (abz-t), which holds a 40% interest in the Diavik project being developed in Canada’s Northwest Territories. The remaining interest is held by a unit of London-based Rio Tinto (rtp-n).

When the joint-venture was signed, Aber secured the right to market 40% of Diavik’s production independently. And long before mine construction began, it negotiated a deal to sell a portion to upscale jeweler Tiffany & Co. Now Aber getting accolades from analysts for its boldness and foresight.

Aber is also building a sorting facility in Toronto to sell Canadian-provenance stones directly into the U.S. and other markets. Diavik will become Canada’s second diamond mine. The first, Ekati, also sells a portion of its production outside the De Beers marketing channel.

“Diavik production is highly desirable in the U.S. market,” Smith notes in a research report. “We think the marketing agreement with Tiffany & Co. is the first step in Aber’s marketing strategy for the lucrative U.S. market.”

Diavik is expected to begin production in 2003. Initial production is targeted to exceed 7 million carats annualized, because of the higher grades at the top of the A-154 South kimberlite.

“During the first full year of operation, Diavik could generate over US$600 million of revenue and an operating margin exceeding 80%,” says Smith. “Based on our current assumptions, Aber will report earnings per share (EPS) of $2 in 2004 and $3.20 cash flow per share. We expect Aber to trade initially at 12-15 times 2004 EPS, a $24 to $30 target.”

Smith’s short-term target of $17 is based on a 5% after-tax valuation. “As Diavik moves into production, we expect strong earnings will attract a higher market valuation.”

Aber currently has 54.5 million shares outstanding and trades at about $12.55 per share in a 52-week range of $7.50 to $14.60.

Capital costs at Diavik are estimated at $1.3 billion, of which $275 million was spent by the end of 2000. Aber’s share of capital is $520 million. The equity contribution will be about $350 million, requiring about $170 million of debt. “Aber anticipates this debt-financing will be finalized by mid-year,” Smith notes.

The mine plan is based on four kimberlite pipes in Lac de Gras, which will be mined by open-pit and underground methods. Minable reserves stand at 26 million tonnes averaging 4.2 carats per tonne, or 107 million carats valued at US$65 per carat. The mine life is 20 years.

Production is not scheduled to start until 2003, though, if all goes well, it could occur late in 2002, Smith says. Development work in the current year will consist of dyke construction for the A-154 kimberlite, and other site preparations.