Emerging Growth Report on Lucapa Diamond Company (ASX: LOM)


Lucapa Diamond Company Offers a Strongly Undervalued Gemstone Wager

Precious minerals could be a hot commodity no matter which way the economy turns

Emerging Growth Report on Lucapa Diamond Company (ASX: LOM)

Amid the uncertainty of what lies ahead, both in terms of economic resilience and societal stability, 2021 represents hope wrapped in a cloud of ambiguity. On one hand, we’ve passed what will probably go down as the worst year in modern world history. However, lingering effects from the Covid-19 crisis have raised serious questions. Typically, investors turn to precious metals when faced with severe challenges. However, this may be an opportunity to think outside the box with high-value gemstones.

Though precious minerals like diamonds are heavily marketed across the broader retail spectrum, the platform as an investment is a convoluted matter for many, particularly those who are new to the capital markets. Primarily, as Benzinga contributor Edward Odongo points out, diamond-mining stocks tend to be overlooked by speculators because of a lack of price transparency.

As well, the gemstone industry features various grading systems to determine the quality of the target stone, such as cut and clarity. Therefore, investing in the stones themselves are usually reserved for experts in the field. Unlike precious metals, the diamond market outside of the luxury retail sector is not exceptionally user-friendly.

Nevertheless, there is a clear opportunity with companies specializing in mineral mining. And Australia’s Lucapa Diamond Company Limited (ASX:LOM)(“Lucapa” or “LOM”) may be one of the most underappreciated prospects among high-risk, high-reward growth stocks. Currently featuring two major projects — the Lulo Diamond Project and the Mothae Kimberlite Mine — Lucapa is levered to both revenue-generating operations and explorative endeavors.

Most importantly for the prospective buyer, LOM stock is incredibly undervalued relative to its established production trajectory. Therefore, the components of market recognition of said opportunity, combined with the potential upside of Lucapa’s exploration projects could send its shares far higher than where it’s trading now.

Brief Background into the Diamond Industry

Contrary to the spot price of household commodities, the valuation of diamonds has always been a tricky concept. Essentially, the De Beers monopoly controlled prices, leveraging almost 90% market share at the peak of its power during the late 1980s. However, over the next two decades and a half, several events converged to erode De Beers’ stranglehold on the diamond sector.

For further insights into the prior price controls of the diamond market, investors should read Kitco.comcontributor Paul Zimnisky’s excellent write-up on the subject. But to make a long story short, businessman Cecil Rhodes cornered the diamond industry following the massive discovery of precious minerals in South Africa. Rhodes’ aggressive entrepreneurialism eventually became De Beers Consolidated Mines Limited. Through various dealings, the company convinced the world’s rough diamond suppliers to sell their production through its channels.

Over time, geopolitical factors such as the European Commission and the collapse of the Soviet Union chipped away at the De Beers cartel, with the company losing control of the market in the early 2000s. By then, a growing number of producers had decided to sell their supply independently from the cartel.

Absent De Beers’ overt controls, the pricing of diamonds has some clarity in terms of free market dynamics. But that’s also the nuanced element of this sector — it’s now subject to extreme volatility based on those dynamics.

Last year was a prime example. According to Forbes, the Covid-19 pandemic exacerbated weakness in gemstone valuations that have been developing for years in one acute strike. Suddenly, many diamond miners found themselves swimming in red ink as the pandemic forced the closure of non-essential businesses like manufacturers and jewelers worldwide. Pouring salt on open wounds, industry experts declared at the time that those mining operations hanging on the margins will be wiped out.

While the headlines don’t provide much comfort for your typical buy-and-hold investors, contrarians willing to accept risk may have a rebound opportunity with viable diamond miners like Lucapa.

Compelling Reasons to Invest in Gemstones

At the start of the pandemic, very few economists anticipated a reasonably quick return to some semblance of normalcy. With a mysterious virus spreading across the world, many feared a coming Great Depression-style calamity. Thankfully, we have for now avoided such a dire scenario.

Instead, we’ve enjoyed a surprisingly robust road to recovery. That’s not to say that we don’t have major obstacles in the way. The novel coronavirus continues to plague the globe with resurgent cases and a second, possibly more infectious strain. Further, severe unrest in the United States imposes a dark cloud over the response and acceptance of the incoming administration of President-elect Joe Biden.

However, the unrest itself is one of the core catalysts (albeit a cynical one) for diamond-based investments. Back during the Great Recession, many sophisticated private investors sought alternative assets like gemstones. According to Ari Epstein, CEO of Antwerp World Diamond Centre, “Diamonds have always been considered a secure and safe investment in times of economic distress… This has everything to do with the fact that diamonds are a stable store of value.”

In the last major recession, diamonds didn’t have widespread investment appeal. However, demand grew as uncertainty rippled through global financial infrastructures. That led Swiss bankers to travel to Tel Aviv, Israel, to purchase large, polished gemstones for wealth protection, according to Chaim Even- Zohar of the diamond consultancy Tacy.

Indeed, the Diamond Prices Index jumped nearly 15% in a span of two years from January 2010. This was at the height of not only precious minerals but metals as well. However, as inflationary fears subsided and the world economy began stabilizing, diamond prices returned to their median valuation (of the post-De Beers cartel era).

Still, it’s quite possible that we could have another run up in diamond demand as we digest recent troubling headlines. Bolstering this thesis is the price index, which hit a multi-year bottom in July 2020. Since then, demand has been creeping up. Nevertheless, overall demand is below average, hinting that this is an ideal moment to consider gemstone investing.

Fortunately, the bullish narrative for diamonds doesn’t exclusively involve hedging against an apocalyptic event. Rather, because the price for precious minerals is deflated relative to long-term averages, this sector is a potentially profitable play in case of a sooner-than-expected economic recovery.

Well before the coronavirus was a thing, jewelers looked to the Chinese consumer market as an avenue to help boost slumping gemstone sales. Traditionally, Chinese culture values marriage, which naturally bolsters the precious metals and minerals industries. But thanks to the exploding middle class in the world’s second-largest economy, millennial and Generation Z women have bought diamond jewelry as a symbol of financial success and independence.

In addition, China’s economy has recovered faster than many other nations from the coronavirus pandemic. Combined with upcoming events like Chinese New Year (Feb. 12, 2021), the diamond market could see the beginnings of a rebound based on accretive, not fear-based factors.

Closer to home and across first-tier nations, pent-up demand has helped millions of consumers set aside coronavirus infection fears. From a report by Rebusiness Online, “there’s no question that American consumers are itching to make up for lost eating, drinking and socializing time, provided they can do so in what they feel are safe environments.”

“Our biggest point of optimism for 2021 lies in the fact that people want to go out, eat, shop and be entertained,” says Lucas Patterson, executive vice president at metro-Dallas based Bright Realty.

But it’s not just the small stuff either. Many households have canceled important events, such as vacations, marriage proposals, weddings and other deeply personal occasions. With cabin fever hitting a peak while gemstone valuations are down near multi-year lows, this unusual dynamic probably won’t sustain indefinitely.

Riding an Ideal Middle Road

With the diamond market investments still a niche segment for most people, there’s a good chance that Lucapa Diamond Company Limited is your first look at a pure-play precious minerals organization. While this offers much upside potential due to LOM stock being a lesser-known commodity (especially if you’re a U.S.-based investor), you want to understand how a sector’s economy works before diving in.

Similar to precious metals mining companies, diamond miners offer two basic approaches from an investment point-of-view: either stable revenue and earnings streams or unmitigated upside speculation. Almost always, conservative investors opt for the former method.

From information piled by Statista.com, there are four major diamond producers: AlrosaAnglo American(OTCMKTS:NGLOY), which owns a majority stake in De Beers, Rio Tinto (NYSE:RIO) and Petra Diamonds. Combined, they account for 64% of the world’s diamond supply market share.

The organizations that Americans are most familiar with, Anglo and Rio Tinto, are diversified businesses. While they do offer exposure to the precious minerals arena, their valuations are tied to myriad assets, such as copper, iron ore, bauxite, diamonds, uranium, and industrial minerals. On one hand, this offers stability and relative predictability. But on the other hand, growth potential as a shareholder is very limited.

Moreover, stakeholders pay a fairly steep premium for this predictability. At time of writing, for instance, Rio Tinto’s market capitalization is $108.09 billion, whereas its 2019 revenue was $43.17 billion, or a 2.5x premium. Being a well-established business, the upside for speculators is muted.

Not surprisingly, many contrarians have turned to exploration plays in the diamond-mining market. Admittedly, this often has the highest maximum profitability potential. However, the risk is that such a move is an all-or-nothing affair.

New York Times report in 2019 mentioned that it may take four to eight years – and sometimes longer – to develop most diamond mining operations. That’s a long time for your capital to marinate, almost always without the benefit of dividend payouts to hold you over. And because exploration plays can end in utter failure for a number of reasons – no gemstone discoveries, discoveries that are economically impractical to extract, geopolitical disruptions, etc. – these carry the same risk profile as your stereotypical penny stock.

Fortunately, Lucapa occupies a rare middle ground in the diamond-mining market. As a pure play, Lucapa is unencumbered with operations of other metals and minerals. While this exposes LOM stock to a narrow market, the discounting of the diamond price index relative to, for instance, the multi-year highs in precious metals, theoretically gives LOM shares a far more explosive catalyst.

At the same time, Lucapa has characteristics that are akin to major mining operations in that the projects are not wholly speculative; indeed, both the Lulo project (located in Angola) and the Mothae mine (in the Kingdom of Lesotho) are actively producing entities of niche scarce high-value diamonds.

According to a press release from Lucapa, Lulo has produced 17 diamonds that are over 100 carats, representing one of the highest dollar-per-carat alluvial diamond producers in the world. To put some context into this production stat, a flawless diamond of this size can go for auction for more than $20 million.

Furthermore, the Mothae mine has recently commenced operations and has produced 30,000 carats in its first year of production, with four 100-plus carat diamonds to date. Due to the encouraging results, Lucapa has secured funding to commission an approximately 45% expansion of this mine’s processing capacity, which is scheduled for completion by March of this year.

In addition, management announced its first generation of revenue of 2021 from the Mothae mine, selling a parcel of 4,676 carats of rough diamonds for $5.6 million or $1,198 per carat. To date, this is the highest average dollar-per-carat price point achieved by Mothae, reflecting growth and optimism for the diamond market.

A Massive Undervalued Opportunity in LOM Stock

Following the initial disruption of the novel coronavirus, hundreds of millions of people across the developed world found themselves working from home. With a steady income minus the commute, many unearthed extra time to engage in a new hobby: stock market trading.

That’s one explanation for the seeming disconnect between the riches of Wall Street and the pain on Main Street. But another is that the U.S. real interest rate (or the interest rate backing out inflation) is presently negative, and the lowest point it’s been since records were kept.

Basically, negative rates are an unusual dynamic where you pay the bank for holding your money, while the bank pays you to take out a loan. In practical terms, there is a “penalty” for people who stay in cash. Not wanting to accept this guaranteed penalty, rational investors decided to put their capital to work in the equities market.

However, we’ve arguably reached a point where valuations are stretched in mature sectors like U.S. blue chips. In order to keep portfolio growth going, the smart money will seek out undervalued opportunities, likely in obscure or foreign markets. Lucapa fits the description for what intelligent contrarians are looking for.

Nevertheless, this remarkably viable opportunity may not last indefinitely. Primarily, Lucapa issued a presentation a few months ago forecasting that in the next six years, management expects the Mothae mine to generate $190 million in revenue and $67 million in net value. That’s just from one operation, yet the market capitalization for LOM stock is $43.79 million (56.66 million AUD).

We’re talking about a near 77% discount to a reasonable six-year forecasted revenue target at Mothae, not including what proven Lulo can generate from its mine.

Even more astounding is the potential behind Lulo’s kimberlite exploration project. Alluvial diamonds (or diamonds that have been removed from their primary kimberlite source through natural erosive events) have been discovered and actively mined by Lucapa in the area. They feature the compelling attributes of sharp edges and little sign of travel – critical clues that the source of these precious minerals is located nearby.

While Lucapa’s team is taking its time to carefully assess the high-potential region, it has narrowed the search area to specific zones. With any luck, the exploration project will yield high-quality gemstones, the kind which Lulo has outputted for years.

Ordinarily, a diamond-mining play would have a market premium just on the speculative value of an exploration project being successful. But as I said earlier, LOM stock is grossly undervalued based on its known, producing asset count. Whatever Lucapa receives from the more speculative exploration project is a bonus valuation for which the market is completely ignoring.

Therefore, as a component of your speculation portfolio, LOM stock may turn out to be one of the most significant. Unlike other mining investments, Lucapa shares are still trading at a steep discount relative to their beginning-of-2020 price point.

Again, with interest toward alternative investments among sophisticated private investors growing, and many more seeking to rotate out of mature markets, LOM stock is in prime position to be one of the surprise players of 2021 and beyond.

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