DDC
(Dominion Diamond Corporation): A Rough
Cut Worth Holding
By:
Colin Canfield, 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
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.
