Friday, May 12, 2017

A current AIM Holding: Dominion Diamond Corporation (DDC) by Andrew Crossman: “A Canadian Diamond in the Rough”

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.

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

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