If 2013 wasn’t enough of a roller-coaster for investors then 2014 will surely deliver. It looks quite likely that 2013 will close at almost exactly the same price as it opened at, 34.75p. This effective year-on-year flat-lining certainly does not reflect the challenges the company has overcome or the achievements made. Gemfields is on the cusp of becoming the go-to miner for coloured gemstones worldwide, and for that it should command a premium valuation going forward. The current price level leaves much upside on the table for investors to enjoy, and 2014 is likely to be the year that much of this value to be realised.
Brief Review of 2013: A Tumultuous Year for Gemfields:
- Integration of Fabergé
- Marketing campaign launched, with Mila Kunis to act as Gemfields’ champion/ambassador
- International emerald auction ban fears incapacitated by Lusaka’s successful auction, delivering record (at the time) per carat revenues of $54/carat
- Surprise emerald auction held in Jaipur, offering gemstones acquired on the open market
- All-time per carat revenue records broken for lower and higher quality gemstones, with the higher standing at $58/carat (95% gain on 2012), and the lower at $3.32/carat (27% on 2012)
- Total revenues of $48m, EBITDA of $1.2m, loss of $22.8m
Expectations for 2014:
- First ruby auction, sourced from the 75%-owned Montepuez Ruby deposit, located in Mozambique
- General increase in coloured gemstone demand, with up-lift from the western world
- Acquisition of first sapphire deposit
- Agreement between the Government of Zambia and Gemfields regarding emerald auction locations
- Promotion from AIM to main market listing
Value Expectations:
The first two bullet points should drive the company’s financial performance far beyond that of 2013 and deliver record profit and EBITDA levels. This is certainly achievable considering that, just half way through this financial year to date, Gemfields has already clocked up revenues of $56.4m, 17% greater than full year revenues for 2013. If the cost base stays relatively constant between 2013 and 2014, then the company should be sitting on EBITDA of around $9.6m.
Rubies are alleged to command a significant premium to emeralds but for the sake of uncertainty, we will treat the ruby auction’s expected performance as very much like the historical emerald auctions held. So, with conservatism on our side, then the ruby auction could deliver around $25m-$30m in revenues. Using the same assumptions above regarding the cost base, that could pump EBITDA to $35m-$40m.
On top of this, it is very likely we will see another higher and lower quality emerald auction before financial year-end. Let’s say that delivers about $40m in total (Note: this is all speculative and using ball-park figures just to get an idea of the value potential for the next year). These assumptions could give us 2014E EBITDA of around $75m-$80m.
Historically, Gemfields has traded at a very low EV/EBITDA multiple of 4.3x, but regardless, applying this to the expected EBITDA for next year we get an EV figure of $323m (taking EBITDA at $75m). If we shave off net debt to get down to, say $300m, then we arrive at an expected market cap of circa £184m, equal roughly to current levels.
Value & Risk:
It would seem that Gemfields has already much of the next 6 months priced in, assuming that:
- The market continues to value the company as it has done historically. I.e 4.3x EBITDA; and
- My highly conservative state of the world (regarding revenue assumptions) is realized
Much of the discount in the 4.3x historical EBITDA multiple accounts for geopolitical risk as well as historical uncertainty surrounding gemstone supply. This makes the industry a more risky bet because as demand is highly averse to a jittery supply it is susceptable to switching away from coloured gemstones for more easily attainable substitutes.
Additionally, revenues are highly discrete. Unlike a retail chain, revenues come in only a few times a year, meaning that if something goes awry then large chunks of revenue can be at stake. We saw that this year with the Zambian Government’s unwelcome meddling.
Conclusion:
If Gemfields can shed or mitigate these uncertainties the market will begin to allow the company to trade at higher and higher multiples. This will be helped as it diversifies its supply base across multiple deposits and gemstone colours. 2014 should provide a platform where much of this is done, and if a satisfactory resolution is made with the Zambian Government too, then we see no reason why the company won’t pursue a main market listing. As soon as this happens this company will enjoy a phenomenal boost as insitutional asset managers build positions in the stock who have a focus on the mining or luxury sectors. This, as well as the expected developments in 2014, should drive value towards that higher EBITDA multiple of 8x-10x enjoyed by more regular miners.
We recommend buying on weakness ready for multiple positive news developments expected throughout 2014 and beyond. Our initial price target stands at 40p, which is where significant historical support lies for the stock and stands at a slight premium to our basic value estimations laid out in this article.
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