Gemfields specialises in emeralds and rubies, while dabbling in luxury jewellery as well. It has also had historical involvement in platinum group metals, with the 6.54% stake in Sedibelo Resources finally written down to zero.
Along with this colourful strategy, it engages in that rarest of things: a dad joke in an earnings presentation, noting “green shoots” in the emeralds business. Sigh.
It certainly needs some green shoots, as Gemfields is in an extensive capital expenditure phase at a time when prices of these precious stones have been dropping. The mining game is all about trying to find the balance between investment and cash harvesting, while attempting to navigate cycles that are difficult to predict. It’s a risky thing, which means position sizing is your friend when considering an inclusion in your portfolio.
The company needs to deal not only with exogenous factors related to market demand, but also with the risks of variable production. Gemfields regularly reminds the market that it is mining a natural product that is found in various grades, with no guarantees of exactly what is going to come out of the ground.
This can create an unfortunate mismatch of disappointing production at a time when market values are strong, with Gemfields unable to maximise the good times in the cycle. Similarly, production can be strong when prices are weak, driving difficult decisions about stockpiling emeralds and rubies and putting working capital under pressure in the hope that prices will improve.
In summary, if you’re expecting a smooth earnings profile with dependable cash flows, rather invest in Microsoft. Mining is a cyclical industry and Gemfields arguably faces even more production variability than most.
This is evidenced by a 17% decline in revenue for the six months to June 2024. The Kagem mine (which produces emeralds) fell by 19.6% and the MRM mine (where the rubies come from) by 14.6%. These operations collectively represent 94% of group revenue, with the rest contributed almost entirely by Fabergé, Gemfields’s premium jewellery business. Fabergé manages to be even less consistent than the mining operations, with revenue down 21.8%.
Mining is a cyclical industry and Gemfields arguably faces even more production variability than most
Gemfields does not cut or polish rough gemstones and Fabergé doesn’t buy any rough gemstones from Gemfields, so there’s no vertical integration there despite what you might logically assume. Instead, ownership of Fabergé gives Gemfields a front-row seat to the trends in the luxury market (they call it a “mine and market” strategy).
Though total costs declined by 3%, the effect on revenue was enough for earnings before interest, tax, depreciation and amortisation to fall by 32%. It’s also worth highlighting that the seemingly strong performance in costs was driven by an increase in the costs capitalised to intangible assets (that is, moved from the income statement to the balance sheet) and by the movement in inventory levels, with significant inflationary pressure on mining costs and group overheads.
This performance has created some nervous faces in the room when combined with the weak recent auction results. The September auction happened after the interim financial period, so it isn’t reflected in these numbers. We certainly can’t ignore it though, as only 61% of lots were sold at the auction. The luxury goods market is under pressure, and that affects Gemfields’s entire business.
Aside from the broader market headwinds, it really does boil down to the quality of stones coming out of the ground, as evidenced by the average price per carat, which ranges from $4.47/carat for commercial emeralds through to $167.51/carat achieved at the most recent higher-quality emerald auction in June 2024. All eyes will be on the higher-quality emerald auction scheduled for November, with management giving a strong view that the troubles in September won’t be repeated at that auction.
If the green shoots joke about emerald production at Kagem is in play, I’ll take the opportunity to point out that the rubies at MRM are red, based on management’s narrative. Gemfields is struggling to recover rubies in the premium category there, which has a considerable effect on the economics.
Despite this, a glance at the recent ruby auction results shows the opposite trend to emeralds, with the price per carat having increased significantly year on year.
With free cash flow down 87% in the interim period to just $3.3m and an expectation of substantial ongoing capex at MRM for the next year, Gemfields investors need to hope that the November auction goes well and that a decline in global interest rates will support prices in the jewellery market. On the other side of this near-term pressure, there’s all the potential of MRM and the benefits of the capex investment.
The share price is in a downward trend for now, trading at 270c and well above the 52-week low of 212c. There’s no need to be brave here, as a poor auction result in November could drive a sharp decline in the price whereas a decent result won’t wash away all the risks.
Patience is best here.
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