Rapaport Magazine
Industry

Mining Profits

A continued uptrend in rough and polished demand and prices is signaling another profitable year for the mining sector and easier conditions for manufacturers.

By Avi Krawitz
The 2010 earnings season for mining companies culminated in a strong set of De Beers financials, which closed out a positive year for the sector. The common thread among the diamond producers was the rapid recovery in rough prices, which boosted earnings.

De Beers reported that average prices of rough sold by the Diamond Trading Company (DTC) rose 27 percent during the year, continuing the increases seen since the second quarter of 2009 (see graph on opposite page, top). The company explained that restocking throughout the diamond pipeline and a rebound in consumer demand, particularly in China and India, contributed to the growth.

While the numbers were pinned against weak data from 2009, the major diamond mining companies — including De Beers, ALROSA, Rio Tinto and BHP Billiton — had pretax profits that, except for Rio Tinto, also exceeded 2008 levels (see graph on opposite page, bottom).

The De Beers Financials

The data showed that De Beers emerged from the financial crisis in as strong a position as it has ever been in. The company’s shift in strategy over the past few years to focus on profits rather than market share appears to have paid off so far (see the financials summary on page 20).

Net earnings rose to $546 million, from a negative $743 million recorded in 2009, while earnings before interest, taxation, depreciation and amortization (EBITDA) grew 118 percent to $1.43 billion. The De Beers net diamond account, representing total sales — including those at DTC, Diamdel and Element 6, as well as investment income — less cost of sales and expenses, more than tripled to $1.04 billion, its highest level since 2005.

Profits were achieved as costs were cut and efficiencies improved. The company’s cost ratio — combined cost of sales and expenses as a percentage of total sales — fell to 84 percent, from 92 percent in 2009, and 89 percent in 2008. A considerable rise in cash available from operating activities helped boost cash flow during the year to $937 million, compared to negative cash flow of $70 million in 2009, and a negative $100 million in the previous year. Significantly, De Beers debt levels decreased by 45 percent to $1.76 billion, due to a $1 billion equity loan by shareholders.

Maintaining Caution

De Beers sold 38.629 million carats of rough diamonds for $5.08 billion, or an average $131.56 per carat, in 2010. Production increased by 34 percent to 32.997 million carats, indicating that the company sold more than 5 million carats worth of stock it had accumulated during the economic downturn.

The company has set a production target of 38 million carats for 2011, suggesting that supply volumes will be in line with 2010, and that the company expects the uptrend in prices to be the growth catalyst again in 2011. De Beers stressed that it does not expect the same pace of growth to be achieved in 2011 as in 2010. “We expect industry growth to be in line with economic growth, maybe a bit more given the markets in China and India,” Bruce Cleaver, De Beers chief commercial officer (CCO), told Rapaport Diamond Report. “But, there is still reason for caution.”

Cleaver outlined that growth could be negatively impacted by a number of factors, including political instability in the Middle East and North Africa, general economic risk and the high level of bank lending to the industry that still prevails.

Signs of a slowdown were not apparent during the first two months of the year as rough demand remained high and prices continued to strengthen on the secondary market. Average DTC prices rose about 7 percent at the February sight, which was valued at approximately $600 million. Tenders held by Trans Hex and Namakwa Diamonds generated significantly higher prices, while Petra Diamonds reported that continued strong demand helped boost prices by 6 percent to 8 percent at its February tender.

Polished Uptrend

Diamond cutters noted a shortage of “profitable” rough supply, given the high rough prices, but were encouraged that polished prices seemed to move in sync with the rough during the first two months of 2011. The average RapNet Asking Price Index (RAPI) for certified diamonds rose 1.7 percent during the month through February 21 (see graph on opposite page), continuing the improvement seen in December and January.

While polished buyers appear to be more accepting of the new prices than they were in 2010, there remain gaps between the consumer and manufacturing centers, and some resistance remains. Reports indicate that sellers with old stock, which they bought at previous price levels, are prepared to sell those goods at larger discounts so that buyers still have some bargaining tools at their disposal. However, these reserves of old stock are diminishing and dealers have reported shortages of polished goods.

Most encouraging is that the gains by polished appear to stem from positive reports from the retail market. Initial feedback from the Far East indicates that jewelry sales grew during the Chinese New Year period. There was also a continued year-on-year improvement in U.S. retail sales through Valentine’s Day. Still, there remain cautionary signs that demand is being spurred by speculative practices based on buyers’ expectations of further increases in both rough and polished prices.

Polished price growth in February came despite a slight slowdown in trade in the polished wholesale market at the beginning of the month, when most dealers in Hong Kong and China were closed for the New Year vacation. Demand improved as they returned to business and preparations intensified for the Hong Kong show, which began on March 4.

The polished uptrend was also evident in the latest data published by the cutting and trading centers. India’s polished exports rose 23 percent year on year to $2.1 billion during January, although the country’s polished imports jumped 120 percent to $2.28 billion. India’s rough diamond imports increased 16 percent to $1.02 billion. Israel’s polished exports grew 9 percent to $617.9 million in January. Belgium’s January trade data was not available at press time.

Growing Confidence

The mining companies will view these trends as a signal that they can build this year on the growth seen in 2010. Their insistence that the pace of growth will not be as strong as 2010 should hold true, given that last year was one of market recovery, while 2011 may present more mature economic conditions. As a result, many foresee a less volatile diamond market and stability settling in, especially toward the second half of the year.

In the short term, however, the strong polished demand appears to be spurring confidence throughout the diamond pipeline. Cutters are hoping that stability in the rough market will allow room for polished prices to catch up to the rough and provide more space to profit from manufacturing.

So far, while caution may still linger, the concerns are being overshadowed by the positive sentiment emanating from the successes of 2010. A prolonged trend will ensure further profitability for the mining sector. The rest of the diamond industry appears confident for now that trade in January and February is sustainable enough to lay the foundations for a strong year for them too.

Article from the Rapaport Magazine - March 2011. To subscribe click here.

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