Thursday, January 7, 2016

22nd AIM student equity update by Colin Canflied: Dominion Diamond Corporation (DDC): A Great December and (hopefully) a Strong 2016


DDC (Dominion Diamond Corporation): A Rough Cut Worth Holding
By: Colin Canfield, student at Marquette University

 Image result for Dominion Diamond Corporation logo

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 engages in the mining and marketing of rough diamonds. As the Great Chinese Unwind continues to play its course, cracks have turned to deep fissures within the Chinese economy, dragging down consumer and, more importantly, diamond demand

• With low very low debt on the books, DDC looks to continue weathering the storm as larger players like De Beers claim market normalcy while suffering the downturn

• Demand resiliency is the key here with these Giffen goods demonstrating a number of key factors that should create a “floor” of consumption

• Investor lethargy is the key play here in that, despite China’s unprecedented slow down, we can expect a reversion to the long run mean in the medium term

Dominion Diamond Corporation (NYSE:DDC) Since its peak last June, DDC has experienced a steep -52.6% slide as fears of slowing global consumer demand, particularly in China, have driven investor sentiment into bearish territory. With global commodity markets continuing to follow the over-supplied weak demand story, nonmetallic mineral miners have felt the consequential squeeze.

Looking back to 2009, diamonds began to experience a coupling with metallic minerals, namely gold and silver, as hard assets acted as a hedge. With diamond prices doubling over a two year period, they hit a -30% slide in Q3 ’11, until finding their floor in ‘13/’14 as investors realized the underlying strength of consumer demand as a counterweight to investor demand. 

Now, we approach an interesting period for the stones as trends began to replicate the lethargic “quiet” period seen after the mining sell off of ‘01/’02. As investor sentiment stalled, the following 10 month period experienced a sharp 40% pop, with investors who continued bemoaning the “broken” commodity market missing out on significant upside. In effect, DDC’s holds an attractive position within the context of the overall super cycle as investors continue to underappreciate global production issues and the aforementioned strength of consumer demand.

With 60% of Shanghai couples marking their engagement via diamond rings, as opposed to 15% two decades ago, investor concern over slowing Chinese demand is logical, but these Giffen goods are marked by two key qualities that make them resilient to the slowdown. First, demand exhibits a low elasticity to price as consumers often only scale down in carat size, rather than substituting away from the stones altogether. Second, the nature of Giffen good demand itself as “expensive is better” is supported the sharp growth of ultra-hit net worth individuals globally.

What has the stock done lately?

Over the past quarter, DDC has continued to get hammered, losing 16.2% of its value with investors continuing to weigh in the full impact of a Chinese slowdown. As sector momentum trends downward, DDC looks to outperform among precious metals miners given not only the low sensitivity of diamonds to price changes relative to other precious metals with industrial uses, but also as the impact of interest rates kick gold to the curb.

Past Year Performance: Over the past year the DDC story demonstrated an extreme sensitivity to the Chinese slowdown, exhibiting the steepest declines as new market data renewed investor fears on when the economy would get back into its rhythm. While reporting losses on its Q3 earnings, DDC’s .54x P/B is reason for hope as AIM looks to hold onto this bargain buy.


Source: FactSet

My Takeaway

As the long run story of China transitioning from an industrial to consumer driven economy takes time to play out, AIM will need to keep patience with DDC and its management team. Given a D/E of .03, the company’s strong balance sheet will afford investors that patience and actually give the company a great deal of flexibility. With an undoubted return to normalcy undoubtedly on the horizon, DDC can not only weather pending industry consolidation, but actually seize the opportunity to incorporate more leverage and expand market share as growth prospects for future growth materialize. DDC had  great December and looks forward to a strong 2016.




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