Are These Diamond Stocks Still Precious?

Once an infallible investment, diamond stocks still shine but not as brightly.
There was a time when I was bullish on diamond stocks. I’d done a ton of research into how DeBeers created a monopoly on a shiny rock with no intrinsic value, created the myth that diamonds were precious, and then destroyed any competition.
Times have changed. More and more diamond fields have been discovered, DeBeers’ grip on the market has been loosened, and the Internet has made it easier than ever to buy and sell diamonds.
While the supply is still restricted, the busting of the DeBeers cartel has opened up the market.  Demand ebbs and flows with the economy, and the fabricated concept of getting your betrothed a diamond ring remains firmly ensconced in the world imagination.
The turning point came when one of the world’s premier brands, Harry Winston Diamond, sold out to Swatch, of all things.  At one point, Harry Winston stock had fallen 75% off its all-time high in 2007, before Swatch purchased it for 23x earnings, or about $1 billion, which included $250 million in debt.  The new entity is called Dominion Diamond (NYSE: DDC), and owns shares in two Canadian diamond mines as well as its retail operations.
Dominion just reported earnings, in which rough diamond values increased 8%.  Sales grew 6% YOY, while gross margin doubled and operating profit tripled.  Continuing operations EBITDA doubled to $109 million.  Profit was $26.6 million.  The company has $267 million in cash and no debt.  It trades at 23x earnings, so given the Harry Winston buyout was at the same multiple, figure the stock is fully valued.
Blue Nile (NASDAQ:NILE) is a diamond retailer that has been struggling.   Retail is never a great game, especially if you are held captive by the sellers of the product you wish to resell.  NILE’s earnings showed a 1.3% sales decline, a 3% margin, and earnings fell from $0.07 to $0.05 per share. Although it has $39 million in cash and no debt, the company is far more subject to competition than ever before.  Six or seven years ago, nobody was really selling diamonds other than in stores.  Now they can be found everywhere online, and that compresses margins.  I’d avoid Blue Nile.
Zale Corporation was bought out earlier this year by Signet Jewelers (NYSE:SIG) for $1.4 billion.  Signet has been on fire and earnings are exploding at 25% per year.  With the stock at $117, that means Signet may even be undervalued on FY14 earnings of $5.51.  It’s got $249 million in cash and no debt. FCF is modest, at around $100 million, but Signet appears to be the jewelry superstore with almost 1,500 stores in the US and almost 500 in the UK.  If you are going to go into retail jewelry, best to become the Home Depot (NYSE:HD) of retail jewelry.
All of these are reasons why the famous Zale Corporation (NYSE:ZLC) is sitting at $3.74 per share, off 90% from its all-time high. Zale has been losing tons of money year after year (a $112 million loss last year, with no end in sight), and has almost $500 million in debt, while it struggles with negative cash flow. The company is in very real danger of bankruptcy, which should serve as a cautionary tale for all of the other names in the sector.
Rio Tinto (NYSE:RIO) owns diamonds mines but also tones of other mineral-producing mines.  So if you want to go with a diversified resources play, which I always think is better than a pure-play in a market that is still changing, RIO might be a choice.  I just don’t like the $25 billion in debt it carries, even if offset by $10 billion in cash.  Long term EPS is pegged at 25%, yet the next two years it appears EPS won’t move much at all.
If you’re going the diversified resource route, think about BHP Billiton Ltd. (NYSE:BHP).  The company is in the petroleum exploring and marketing business, and holds potash exploration rights for 14,500 square kilometers in Canada. It also produces and supplies primary aluminium, alumina, nickel, and manganese ore and alloys.  It explores for and produces copper, silver, lead, uranium, zinc, and iron ore.  This is a cash flow business and in its good years, it can produce $18 billion of it.  In its bad years, it can has negative $5 billion.  Tread carefully.
Lawrence Meyers does not own any stock mentioned.

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