Charles Stanley says DiamondCorp's share price underestimates Lace Mine's potential

Charles Stanley has initiated coverage on DiamondCorp (LON:DCP) with an ‘add’ recommendation and an 11.5 pence price target – which is almost double the current share price.

In a note to clients, analyst Kieron Hodgson actually values the Lace Mine in South Africa at £55 million, or 23 pence a share.

But he applies a 50 per cent discount that reflects the risks associated in rehabilitating the operation, which can trace its roots back to the early 20th century, and recommencing production there.

Positive results from bulk sampling at Lace has given management led by Paul Loudon to the confidence to develop Lace, which should go into production in 2013.

The share price, down around 40 per cent to date, under-estimates the mine’s potential, according to Hodgson.

It also ignores completely the company’s Jwaneng South Joint Venture, the analyst adds.

“The results from this sample should enable investors to ascertain the potential resource base and recoverable grade from this highly prospective exploration programme. We expect results to be published by the year end,” Hodgson explains.

The share price, meanwhile, reflects the general negative sentiment that has dogged the small-cap sector for months now as investors have checked out of supposedly risky investments as the sovereign debt crisis has played out in glorious Technicolor.

Investors in DCP specifically are bracing themselves (possibly wrongly) for further dilution as the company assesses its funding options for Lace.

Last month it raised just over £2 million from investors – a move which will allow it to concentrate on pulling in the project finance required to develop the mine.

DiamondCorp has published revised development plans to by-pass the mine’s historic working and instead aim straight for the lower lying, higher grade kimberlite.

This new plan has a capital cost of £11.4 million. The company now plans to secure project finance, rather than raise additional equity, to cover these costs.

Explaining the decision to seek project financing to complete the Lace development, Loudon said: "Markets for resource stocks are experiencing a difficult period at the moment, and financing the whole of the Lace mine development from equity capital cannot be done without an unacceptably high dilution to existing shareholders.

“Therefore management will now turn its attention to investigating sources of project finance for Lace in a form which provides the least dilution and maximum leverage for existing shareholders.”

While the DCP has suffered, it has still outperformed Firestone Diamonds (LON:FDI) and Namakwa Diamonds LON:NED), whose shares are down 60 per cent and 80 per cent respectively.

Hodgson, meanwhile, suggests his 11.5 pence valuation of DCP is conservative.

“Our comprehensive mine valuation assumes zero special stone sales and a conservative production growth profile over the life of the operation,” he explained.

At 10.45 am, the shares were changing hands for 5.88 pence, down almost 6 per cent.