dazzling diamonds: the business case for investing in diamonds

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James Campbell June 2, 2016 Dazzling DIAMONDS

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James CampbellJune 2, 2016

DazzlingDIAMONDS

Diamond Market TrendsPortrait of the Diamond Industry

OpportunityCapturing Investment Momentum

InvestingIn Diamond Companies

AGENDA

Portrait of the Diamond Industry

I.MARKET TRENDS

Recent Diamond Market

• Structurally industry has settled

• Limited M&A activity

• 2015 was a tough year for diamond producers

• Rough diamond demand fell away significantly

• US$16bn rough diamond supply fell to US$13bn

• Differing views as to exactly why correction took place

• High rough prices

• Overhang of polished

• Middle market choked; no margins; reduced liquidity and bank finance

• Decline in polished diamond demand from emerging markets, particularly China and India

• Major producers suffered circa 30% drop in sales

• 15-20% drop in market rough prices

• Production curtailed, some mines on C&MNote: Tier 2 = RT, DDC & Catoca combined; Tier 3 = Petra, Gem, active new minesSource: Author’s research, public information

Key Rough Suppliers - SalesUS$bn

0

1

2

3

4

5

6

7

2007 2008 2009 2010 2011 2012 2013 2014 2015

De Beers

Tier 3

Tier 2

Alrosa

Price IndexRough Diamonds

• Pricing trend is upwards

• However volatility in market pricing is clear to see

• Prices fell 15-20% in 2015

• Creates instability and challenges for the trade

• Fragmented supply with differing sales models

• Increase in tenders and auction sales

• De Beers dropped prices -7% in January; raised prices +2-3% in April

• Rest of year predicted to remain stable

Diamond Price IndexIndex Jan. 2001 = 100

Rough Polished

Linear (Rough)

Source: DDA Trading, May 2016

Improving Diamond Performance

• 2016 has seen a much stronger H1 as restocking takes place

• “Normal” volumes being sold into the trade

• Jan-May 2016 DB & Alrosa sold $4bn+ into market (FY2015 $7.5bn)

• Jan-April 2016 +18% vs 2015; -13% vs 2014

• Fragile recovery, but a recovery

• DB adjusted prices 7% in Jan, but +2-3% in April

• Potential roadblock ahead H2 as fresh polished comes from factories

• No major pull of new polished demand

• All eyes on JCK show in Las Vegas

• India considered the bright hope for mid-term growth

0

2000

4000

6000

8000

De Beers - Annual SalesUS$m

2011 2012 2013 2014 2015

De Beers - Sight-by-Sight SalesUS$m

0

200

400

600

800

10 1 2 3 4

2015 2016

Source: Author’s research, public information

2016 Diamonds Dazzle the World

• Certainly not all bad news in the trade

• Strong demand for exceptional large stones and fancy colours

• Record prices achieved

• Public and media interest creating a significant halo effect

© Christie’s

Constellation813CTS, $63m+

Oppenheimer Blue14.62CTS, $58m

Lesedi La Rona1109CTS, $???m

ConsumerDemand

• Global DJ retail sales -2% (US$79bn)

• US market a bright spot; record US$39bn diamond jewellery sales

• Non-US markets saw decline in local currencies, further impacted by strong US dollar

• India remains a big hope for the industry

• China growth success story on hold for now

• New efforts to invigorate the market underway

-20%

-10%

0%

10% US+5%

China-1%

India-9% Japan

-13%

M. East/Gulf-3%

Diamond Jewellery Demand by MarketPerformance 2015 vs 2014, based on US$

US45%

Rest of the world19%

Gulf8%

Japan4%

India7%

China(incl. Hong Kong and Macau)

17%

Global Sales2015 – by value

Source: De Beers Group - Market Insight Report, April 2016; Figures based on US$ at Polished Wholesale Prices

SupplyLandscape

• Widely projected peak in supply by 2021

• Followed by gradual supply decline

• Ageing mines will close

• Argyle - 20mcts p.a. scheduled to close by 2020

• Recent large Zimbabwe production has reduced significantly

• Limited new mine potential

• Exploration budgets/activity have been reduced

• Few new discoveries reported - Angola

• Very long-lead time to production

• Not all discoveries will lead to production

Rough Diamond - Supply2008 – 2030 (base scenario)

Millions of carats

Note: Smaller players are Dominion Diamond, BHP Billiton for 2008-2012, Petra Diamonds, Gem Diamonds and CatocaSource: Bain & Company – The Global Diamond Industry 2015

Forecast

2009 2011 2013 2029F

180

150

120

90

60

30

0

2023F 2025F 2027F2015E 2017F 2021F

New mines

Other mines

Smaller players

Rio Tinto

De Beers

ALROSA

2019F

Capturing Investment Momentum

II.OPPORTUNITY

Supply demand gapThe Opportunity

• Demand will continue to grow, despite bumps in the road

• Middle-class development in China & India alone will drive significant demand growth

• In next 15 years, China (200+m) & India (100+m) new middle-class households

• On top of this - mature, robust markets such as the US will continue to perform

• Not all diamond development projects will come into production

• Potential for significant price growth

• Need to capture the imagination of the Millennials and beyond

• BUT there are clear threats……

Rough Diamond - Supply and Demand2000 – 2030 (2015 prices)

+/- 2bncts known reserves

2001 2007 2011 2015E 2019F 2023F 2027F 2030F

Low demand

Base demand

Base Production

Stable Production

$ billions

16 years’ productionat current levels

Source: Bain & Company – The Global Diamond Industry 2015

Supply demand gapThe Opportunity

• Lab-grown diamonds are here and growing

• Swarovski has launched recently a Lab-created diamond jewellery brand

• Not a current threat to larger diamonds

• Lack of generic advertising has hurt natural diamonds

• DPA formed by 7 leading producers to maintain consumer confidence and drive future demand

• Launch of first marketing campaign at JCK in June

• Targeting Millennials to regain lost ground

• Need to position for future 2-tier retail environment

• US - Recycling Diamonds – De Beers/IIDV

Supply demand gapRisks

In Diamond Companies

III.INVESTING

Investingin the Diamond Industry 1/2

• Mining stocks and indices have had a torrid time

• Diamond industry is not immune

• Producer performance has not been as good as expected, with one notable exception

• Exploration funding has been difficult

• Market has strengthened in 2016

• Better results expected across the board

• Despite market and price volatility diamonds have outperformed other commodities

• Opaque trade changing

• Both 2 main producers are becoming increasingly transparent

• Price growth should drive company values

Indices EvolutionAs of January 2012 — 100 = January 2010

Price Indices for Diamonds and Other Commodities100 = January 2010

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%

Jan-10

May-10

Sep-10

Jan-11

May-11

Sep-11

Jan-12

May-12

Sep-12

Jan-13

May-13

Sep-13

Jan-14

May-14

Sep-14

Jan-15

May-15

Sep-15

Jan-16

- Rough price - Polished price - Gold Price - Commodity Price (non-fuel) - Metals

Source: Author’s research, Google Finance, Indexmundi, S&P, DDA Trading

0%

50%

100%

150%

200%

250%

300%

Jan-12

Mar-12

May-12

Jul-12

Sep-12

Nov-12

Jan-13

Mar-13

May-13

Jul-13

Sep-13

Nov-13

Jan-14

Mar-14

May-14

Jul-14

Sep-14

Nov-14

Jan-15

Mar-15

May-15

Jul-15

Sep-15

Nov-15

Jan-16

Mar-16

S&P GlobalMining

Rio Tinto share price

S&P/TSX Capped Diversities Metals & Mining

AlrosaShare Price

S&P 500

Investingin the Diamond Industry 2/2

• Consolidation opportunities across the pipeline

• Highest profit pool in mining and rough sales

• Investment-grade diamonds strong

• Explorers – high risk; long-lead time to production

• Consider geographic logic – Africa, Canada

• Upstream investment by retail - Tiffany

• Limited options; possible IPOs (De Beers, Rio Tinto Diamonds)

Industry Player ConsolidationA view – producers, current

10,000

10,000

M Cap (US$)

Annual RevenueUS$m

1,000

100

10

10 100 1,0000

Diamcor

DiamondCorp

Rockwell

Transhex

Firestone

Gem

Rio Tinto Diamonds

Dominion

Lucara

Mountain Province

Alrosa

De Beers

Petra

Kimberley

Lucapa

Source: Author’s research, public information

Profit Pools2015

Mining/Rough Sales Trading/Cutting/Jewellery Retail

18 – 22%

0 – 5%

4 – 11%

0

10

20

30

CONCLUSION

Big growth opportunity is coming

Supply-Demand gap coming next decade

US & Emerging Markets

Rough price growth

Threats will need to be mitigatedLab-grown Diamonds

Liquidity issues

Recycling Diamonds

Work underway to recapture growth initiative

Diamond Producers Association

Consumer Confidence programmes

Consolidation opportunities existUpstream

Retail

Compelling investment case

INDUSTRY FUNDAMENTALS REMAIN STRONG

Plant workers at Saxendrift Hill Complex

James [email protected]