Whenever you buy a share which you view as a potential recovery play, you have to accept the risk that it may do everything but actually recover. Although the assets of Petra Diamonds (PDL) are still of value in my view, the high level of debt, alongside recent updates, looks to have significantly reduced the chances of a positive outcome for existing equity holders...
When I covered this company last year I was hopeful that diamond prices might strengthen, on the basis that the worlds largest diamond mine, Argyle, was closing. But they continued to weaken further, and although they’ve picked up slightly at the start of this year, it isn’t enough to reverse the damage. The company had net debt of $596 million at the end of last year and it had actually risen slightly compared to the previous quarter. This debt comes as a result of the purchase and development of its diamond mines in South Africa, but it appears that it invested heavily at the wrong time and has been unlucky with the drop in diamond prices – which is always the risk you take with any natural resources producers which have had to engage in large amounts of Capex for their projects.
Production from its mines - including the famous Cullinan mine that is known for its large, high quality diamonds - has been improving, but that hasn’t been enough to offset the fall caused by diamond prices, and as a result revenue has reduced, and it is still making a net loss, with very high finance costs. Its interims showed revenue of $194 million and a net loss of $10 million for the six month period. The situation doesn’t look likely to improve either in the near future, and Project 2022 - which it launched to try and improve cash flows to give it a chance to reduce bond debt when it comes due in 2022 and give it a better chance of refinancing the remainder - was originally forecast to generate $150-200 million cash flow over a three year period, but that has now been lowered to $100-150 million.
So far lenders, who aside from the bondholders mainly consists of the BEE and associated banks, have been understanding and have waived the covenant breach that would have occurred when those were assessed in December, and although I see it as unlikely that they would make the situation worse, given their stake in the business and the local workers, there is no guarantee that they will continue to waive further breaches this year. One thing that is encouraging is that the BEE has maintained its credit facility, meaning that the company does still have $147 million available to it and no immediate concerns over meeting its shorter term liabilities. The real problem is going to come in a couple of years when those bonds/notes become due - $650 million in May 2022 - as with a market cap heading towards £50 million, even if it was to carry out a rights issue, like South African platinum miner Lonmin did to refinance the balance sheet, it seems doubtful that it could raise a sufficient amount. There is also a possibility that refinancing could occur via the issue of new bonds, but for that to have any chance of happening I think that the diamond market will need to be much stronger and the company will have to at least be making some sort of profit.
Another possibility of course is that given the historical performance of the mines and the quality of diamonds that they produce, a larger miner might be interested in making a bid for the company, as without the debt servicing it would be profitable, but even if that was to occur I would expect it to be at a knock-down price to reflect the size of debt that any buyer would be taking on/settling in the process. I now see the chances of a recovery as being lower than when I previously covered the company as a speculative buy, and with significantly higher risk, and on the basis of all the available information at this point, I’m intending to sell here before the shares potentially fall further, although I may wait to see if there is any sort of bounce in the share price first.
Filed under: Petra Diamonds, Versarien, Firestone Diamonds, SIG, Tertiary Minerals, Ariana Resources
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