I hold KIM shares.February 28, 2007Kimberley Diamonds Could Be...

I hold KIM shares.

February 28, 2007
Kimberley Diamonds Could Be The Reason For Gem Diamonds Raising So Much Money.

By Our Man In Oz.

Frustrated, or flattered, that’s the emotional roller-coaster for Miles Kennedy, the man behind Australia’s No.2 diamond producer, Kimberley Diamond. On one hand he is frustrated that the investment world can’t see in Kimberley what he can, a business which has survived a series of setbacks to reach the cusp of success. On the other, he is flattered that some close observers are starting to see Kimberley as a plum takeover target because its share price is not yet reflecting the change underway in production and future profit. Last week, as the takeover chatter gathered strength, and even named a likely bidder, Kennedy was forced to issue a formal rebuttal. “Kimberley Diamond wishes to advise that it has not received any proposal for a takeover from Gem Diamonds or indeed any other company.”

Naturally, the market took the naming of the freshly-floated and cash heavy, London-based Gem in precisely the opposite way to which Kennedy intended. Rather than hose down speculation it was kerosene on the fire with Kimberley’s share price scurrying up from A92c to A$1.07 on Monday, in the heaviest trade for at least 12-months. At those prices Kimberley was still well short of last year’s high of A$1.96, but up on the low of A67c reached a month ago. Wednesday, as it was for all stocks, produced a correction, though Kimberley’s 6.5 per cent decline was among the smaller falls. Investors, it seems, have re-discovered Kimberley, either as a takeover target, or as a company which is about to deliver on its promises.

Kennedy, after investing 14 years of his life plus A$195 million of shareholder’s funds and bank debt, is keen to see the fruits of time and money, though he also acknowledges that getting this far has been a rocky road. Speed bumps encountered include failure to deliver on promised production, confusing investment presentations, depressed diamond prices caused largely by Indian cutters mismanaging their affairs, and troubles with plant expansion projects. The latest hiccup saw Kimberley forced to remove a plant engineer from its Pipe 9 project, and assume control of construction. Despite these events, Kennedy is confident that Kimberley can still hit its target of producing 650,000 carats of diamond a year, and cement a place among the world’s top 10 diamond producers.

Minesite caught up with Kennedy in his Perth office last week, just before the Gem Diamond takeover speculation surfaced, and started by asking whether this time, Kimberley was emerging from its difficult period. “It’s going to depend on the performance of Pipe 9,” he said. “I’m a bit gun-shy about giving a direct answer, and even though we’re saying it will take another eight-to-10 weeks, I’ve travelled that road before.” Despite his reluctance to put a firm time on completion of the latest plant work at Ellendale there seems little doubt that Kimberley is well on the way to finally achieving what was promised in 1993 when it embarked on a plan to acquire Ellendale from its original owner and discoverer, Rio Tinto.

The plan for Ellendale is to start working the most profitable of a “swarm” of 43 kimberlite pipes. The plant at Pipe 4 has been designed to process 4.4 million tonnes of ore a year with future expansion possible to 5 million tonnes, and the plant at Pipe 9 has an initial target of 3.3 million tonnes, expanding to 4.4 million tonnes. With additional feed likely to come from other nearby pipes the overall aim is to process 10 million tonnes of ore a year for the recovery of between 650,000 and 700,000 carats of diamond. When that is achieved Ellendale will be a diamond producer of substance. “In terms of the western world producers, excluding Russia, we will rank fifth,” Kennedy said. “If you eliminate Aber Resources, which isn’t a miner but simply takes its share of the Diavik mine in Canada, and look at us as a pure, listed, diamond play it puts us at No.1 or No.2.”

It’s the combination of factors which makes Kimberley a target of takeover gossip. There is little doubt that the company has not done itself any favours by over-promising and under-delivering, but there now seems equally little doubt that a major expansion phase is nearing completion, that production is about to start rising strongly, and that the diamond market is poised to recover from a difficult 2006. “We can certainly see better times ahead in the diamond market,” Kennedy said. “To put it into context, there are 25 operating hard-rock diamond mines in the world. Not one of those will be operational within 20 years. We are going to see from 2009 a very, very, sharp drop off in production. I think there is a genuine diamond shortage emerging.”

“In the market we’re already seeing a recovery from difficult trading conditions,” Kennedy said. “The 12-months ahead looks like being a balancing year, though it depends on your production. A great proportion of our production is two carat stones and bigger, and the world is running out of two carat stones. We’re seeing quite significant price increases in that category.”

Kennedy said outside observers sometimes overlook how quickly Kimberley had developed Ellendale. “We only completed the acquisition in April, 2002,” he said – a point Minesite picks up by suggesting that the acquisition process actually started well before that. “Ahh, yes,” said Kennedy. “That started in 1993, so that took nine years.” First production actually took place in July, 2002, when an exploration plant was converted into a commercial facility. “By our fifth birthday, we’ll be over eight million tonnes, employing 450 people, having built 100 kilometres of roads, 20 kilometres of borefield, and having done all that in an extremely remote location.”

For investors, who have sometimes been frustrated by Kimberley’s stop-start progress the next few months are critical. Raiders are undoubtedly circling the company because it is a rare example of a significant diamond producer with a wide open share register, with rising production, and a depressed share price as everyone stands aside waiting for the successful completion of a major expansion project. Kennedy, however, is in no doubt that this time he has the issues nailed, including profitability. To test the profits issue Minesite gently probes the issue of profit per carat. “We talk in terms of cost per tonne and value per tonne, but you get the same percentage,” Kennedy said. “Basically, the value per tonne (of ore) is around A$17, and our costs per tonne in steady state production will go to A$11 per tone. So there’s going to be a margin of around A$6 per tonne”-- which, should leave Kimberly at a production rate of 10 million tonnes a year with around $A$60 million sticking to its accounts; yet another reason for the interest in Kimberley to be rising.

It may prove to be pure coincidence, but Gem Diamonds raised £297 million when it listed last week. Its priorities are to double production from its Letseng kimberlite mine in Lesotho and bring two alluvial mines into production over the next year. None of this should cost more than half what Clifford Elphick now has in his back pocket and it just so happens that Kimberley Diamonds is currently capitalised at around £150 million. There would be shrieks of opportunistic if he made a move in that direction, but the best deals usually are opportunistic. What will be weighing on Elphick’s mind is that he will only get a chance to buy a company like Kimberley once in a lifetime.