Gemfields (LON:GEM) is a unique play on the coloured gemstones sector, according to SP Angel, which has initiated coverage of the stock.
The resource sector specialist said it likes the investment case for Gemfields, which is supported by a fundamental value on a sum of the parts basis, but fears temporary head-winds in the luxury goods market could hold back the price in the short-term.
Results from Gemfields, which has mining interests in Zambia (chiefly emeralds) and Mozambique (chiefly rubies), are due out on Wednesday and analysts are bracing themselves for a drop in reported earnings, but the team at SP Angel predicts earnings should pick up over the next two to three years.
“With successful execution of an expanded mine plan, build up in sales to match production, there is significant scope to grow both the top line and earnings,” SP Angel asserts.
The broker ascribes a value to the Kagem emerald mine of US$317mln on a net present value basis, while the Montepuez ruby asset is valued at US$595mln; Gemfields does not own the mines outright, and SP Angel's estimate of the worth of Gemfields' shares is US$684mln, or £452mln, giving a per share value of 82p, 26p above Gemfields' current share price.
The market size for coloured gemstones is estimated at US$4bn, and the market is dwarfed by the diamond market, which is almost seven times larger.
Sales from Gemfields currently stand at around US$153mln but are set to grow to US$315mln in fiscal 2018, SP Angel said.
Gemfields is doing its bit to address the imbalance between demand for diamonds and coloured stones, operating a grading process and also a successful branding process spearheaded by actress Mila Kunis, who is the face of the company.
“To this extent Gemfields is a 'price maker' rather than a 'price taker' as is the case with the majority of diamond producers. Building demand in the market therefore has resulted in a higher marketing and sales budget than for the diamond producers of around 5-10% and more capital deployed in inventory management. This could result in lower immediate free cash flow to price takers such as Petra Diamonds but puts pricing for gemstones on a more sustainable footing,” SP Angel argues.
Mine plans show that the company plans to increase production, both for its emeralds and rubies businesses, and one of the key challenges the broker sees for the company is managing the increased supply to the market.
This may be less of an issue for the higher value goods where scarcity should support demand, as is the case with special diamonds.
Both emerald and ruby prices have moved up for high value stones in the last 10 years with the same demand dynamics as higher quality diamonds, SP Angel notes.
The shares have outperformed the AIM mining sector by close to 118% and have not weakened in the recent rout in the diamond sector and for luxury goods.
The broker's recommendation is to hold the shares and buy on any signs of share price weakness.