Dominion
Diamond Corporation (DDC, $12.78): “This is truly a diamond in the rough”
By:
Andrew Crossman, AIM Student at Marquette University
Disclosure:
The AIM Equity Fund currently holds this position. This article was written by
myself, and it expresses my own opinions. I am not receiving compensation for
it and I have no business relationship with any company whose stock is
mentioned in this article.
Summary
• Dominion Diamond Corporation. (NYSE:DDC) mines, sorts and markets
rough diamonds to a worldwide clientele base. It operates two mines in northwestern
Canada.
• DDC’s Ekati diamond
mine shift in production from high-value ore to lower-value ore and production
shutdowns lead to lower gross margin.
• Management concerns
continue as demonetization of India, a sales site of DDC, attributes to a poor
economy and lower sales figures.
• Expansion potential
leaves management optimistic for the future of development for the Lac de Gras
region within the boundary of the Ekati mine.
• Institutional investors
increased positions signify a bet on expansion of reserves.
Key
points: Dominion Diamond Corp. exercises controlling interest
of their Ekati mine. It has been long anticipated that proven reserves of high
quality diamonds would expire in 2016. Management has emphasized a switch to
lower-quality diamonds and emphasized increased production quantity to mitigate
lower gross margins (CY16 7.2% gross margin CY15 25.5%). Additionally, lower
margins were partially affected by a jeweler strike in 2016.
India’s federal
government announced the demonetization of two bank notes in an attempt to end
forgery. One of Dominion’s two sales sites (the other located in Brussels) felt
the effect of the subsequent shock to the Indian economy. In their latest
earnings call, management stated they were expecting a price drop of 5% to an
average price of $55 per carat. The exact effect that demonetization on sales
cannot be directly measured as Dominions sales figures were increased in Q4 by
the unloading of inventory.
DDC holds ownership of a
large area around current mining sites at Ekati and Diavik which they plan to
us as expansion to current reserves. Especially at Ekati, management has
emphasized extensive testing of 110 known kimberlites (rock type known to
potentially contain diamonds) on current mining property. An R&D budget for
2017 of ~$8 million (263% increase over $2.2 million in CY16) is an example of
management’s actions to expand current reserves.
As existing mining
methods deteriorate, expansion of reserves is crucial to the survival of DDC;
institutional investors continue to take positions indicating that they believe
Dominion has found the answer (institutional ownership has increased $191.2
million since Q4 FY15). Three long term growth projects promise to increase
proven reserves by up to 104.7 million carats. Not on currently mining
property, but close enough to take advantage of established transportation, the
Jay, Sable, and A-21 pipe could be the driving sources behind future earnings.
These projects are currently in early stages of development, and the largest of
the three (Jay) could promise 84.4million carats as soon as FY19.
What
has the stock done lately?
On March 20 2017, the
company was the subject of acquisition from Washington Companies for $13.50 per
share. Since March 14, the stock has surged 42.94% although management has not
yet accepted the acquisition offer. It has been assumed that this acquisition
offer could draw competition from other groups looking to expand their
materials portfolio.
Past
Year Performance: DDC has increased 14.72% over the past
year. The current price of $12.78 represents a discount of 28.4% over
accounting book value per share. The market’s concern about decreasing
production and performance could explain why the stock is currently trading at
a discount to its intrinsic book value.
Source:
FactSet
My
Takeaway
Dominion Diamond Corp
poor performance detracted from share prices since it was added to the AIM
portfolio in November 2013. Poised for a turn around of operations driven by
expansion projects, DDC finds itself as a qualified candidate for acquisition
as shown by the offer by Washington Companies. Managements hesitation to accept
the offer which falls below the book value per share indicates confidence in
future performance which will drive stock price ultimately towards a price
target of $15.
Currently, the AIM
international portfolio is overweight in Canada and despite management’s
expectations the stock, this tender acquisition offer could represent an
opportunity to exit a position which has underperformed. Rebalancing the
portfolio to be more geographically neutral and lowering exposure to macro
risks in the Canadian economy.
Source:
FactSet
