Diamond: Waiting To Exhale

- December 7th, 2009

The diamond industry braces for more hardships as Black Friday sales brought in little green. The landscape appears bleak. Will De Beers $1 billion rights issue and Africa Israel’s $2.1 billion debt shenanigans bring out the sun?

By Kishori Krishnan Exclusive To Diamond Investing News

Its the season to be jolly – but the diamond industry is having none of that.

With many producers still gasping for air post the economic downturn, the crucial period for consumer spending between Thanksgiving and Christmas has got the industry in a bind.

According to reports, the festive-season buying in the US got off to a humble start, with consumption rising 0.5 per cent year on year on the traditional start of holiday buying, known as Black Friday.

Analysts maintain that consumers’ humbler tastes might make it tough for diamonds to recover. More shoppers spent less. And the recessionary slump that pummeled demand and led miners to cut production appears to be taking its toll.

Americans spend about $30 billion each year on diamonds, and about $60 billion on jewelry overall, according to Idex Online, an industry site. Demand for diamonds plunged in the aftermath of the stock market collapse last year.

Interestingly, diamonds could be the new gold when it comes to safe investments.

Lean winter

Clearly, US shoppers are keeping a padlock on their wallets. According to the National Retail Federation, online and store shoppers spent US$ 41.2 billion during the Black Friday weekend that starts with US Thanksgiving. The total was barely any improvement at all on last year’s disappointing US$ 41-billion.

The Black Friday weekend is supposed to provide the first look at the retailing outlook for the crucial Christmas season.

David Rosenberg, chief economist and strategist at Gluskin Sheff and Associates Inc, a Toronto money manager, said US consumers have started a long-term shift to frugality. Rosenberg believes that the United States is locked in an economic crisis that has more in common with a depression than a recession. “Frugality does not emerge as [a] secular theme in a garden-variety recession, but it does in a depression,” he said.

The continuing pinch of hard times is causing fundamental social change as families look for ways to live on less, writes Rosenberg. Americans are making their own Halloween costumes, postponing purchases, trimming luxuries.

And the latter does not bode well.

The brutal trend is clear: everyone is looking for bargains. That means that profit margins are likely to be thin, and even with aggressive discounting, retailers may not be able to drive much volume.

Grim situation

As for the industry, two major events clearly show that a huge struggle is on to put a cap to declining sales.

De Beers shareholders – Anglo American,  the Oppenheimer family and Botswana – agreed to inject $1 billion in the company in a rights issue as a means of raising its debt profile.

What this portends is that as the trio negotiates to renew a $1.5 billion bank loan facility, which expires in March, they need to raise the asset value of the company to ease potential credit conditions.

The rights issue is designed to help reduce the company’s debts, which currently total $3.5 billion.

The move comes at the end of a bad year for De Beers, which saw first-half profits fall by 99 per cent as a result of a collapse in the price of diamonds.

The slump in demand forced De Beers mines in South Africa, Botswana and Canada to take production holidays earlier this year.

De Beers is 45 per cent-owned by the mining company Anglo American, while South Africa’s Oppenheimer family owns 40 per cent. The government in Botswana owns the remaining 15 per cent.

It is unclear how Botswana, which is itself cash-strapped after diamond exports plummeted to the point where the country had to seek a bailout from African Development Bank (AfDB), will finance the nearly P1 billion for its part of the De Beers ‘stimulus’ package

Low produce

Consumers have been less inclined to buy precious stones in the financial crisis, while demand for industrial diamonds has also fallen as factory activity has slowed around the world.

De Beers last month revealed a 40 per cent drop in diamond production to 7.885 million carats in the third quarter ending September 2009. While output was 43 per cent higher than the previous quarter’s production, full year diamond production is expected to be 50 per cent lower than 2008 levels.

According to a statement: “By reducing De Beers’ level of external debt and improving its capital structure, this investment would better enable the company to take advantage of new opportunities and demonstrate the shareholders’ confidence in De Beers’ continued market leadership as the recession gives way to recovery,” De Beers said.

Citigroup said the fund raising could provide cash to expand its flagship mines in Botswana, the largest diamond producing nation by value.

“A cash injection could facilitate quicker restart of the growth projects in Botswana (Jwaneng) and could reduce interest expense on refinanced debt,” a note said.

Meanwhile, De Beers Canada is planning to ramp up production at its Snap Lake mine adding 175 jobs to the operation. The company expects the mine to reach full capacity towards the end of 2012, a level four times the current output.

Despite a rebound in rough diamond prices in the past two months, Des Kilalea, a diamond analyst at RBC Capital Markets, reckons that 2010 “will be challenging, although, like most things, the industry’s fortunes turn largely on what happens to the global economy”.

Dull shine

Another facet to rock the industry was the news that Lev Leviev entered a hearing this week regarding his real estate investment company, Africa Israel, which has racked up some $2.1 billion in debt during the crisis.

In short, the company’s investments in prime properties in Manhattan and Eastern Europe went sour as the property market crashed.

For the first time this week, court documents indicated that the diamond mogul would probably have to dip into his assets to help relieve some of the pressure on Africa Israel, in which he has a 75 per cent stake.

Leviev is reported to be looking to restructure NIS 7.5 billion of debt after disclosing on August 30 that the company was struggling to refinance long-term loans.

What has clearly been denied, however, is the news that the diamond mogul plans to sell a Moscow jewelry factory to help pay back loans.

Both these issues, coming against the backdrop of one of the worst periods seen in the diamond industry, and the news about Dubai World’s debt troubles, have sent the industry majors into a huddle.

Where is the Christmas spirit and where is the much-needed cheer?

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