Gemfields Group — Cash preservation ahead of December auctions

Gemfields has provided an update on its operations and corporate position, focusing on the company’s response to COVID-19. Operations at Kagem and MRM have been suspended since March and April, respectively, and Gemfields has now extended the shutdown at MRM until 30 September and at Kagem until 31 October. Gemfields intends, if possible, to hold an emerald (higher quality) and a ruby (mixed quality) auction in December. The company ended June 2020 with cash of US$53.6m and net cash of US$9.3m. Gemfields is working to reduce costs and thus cash burn while operations are suspended; however, if auctions cannot be held in December as planned, Gemfields may need to look at options to secure additional funding.

Gemfields generates more than 90% of its revenues from emerald and ruby auctions usually comprising two high-quality (HQ) emerald auctions (May and November, usually in Singapore), two commercial-quality (CQ) emerald auctions (February and August, usually in Lusaka) and two mixed-quality (MQ) ruby auctions (June and December, usually in Singapore). The challenge from a practical perspective is that these auctions rely on customers travelling from multiple countries to carefully inspect the stones and determine the value of their bids. This process cannot take place remotely without providing the customers physical access to the stones. For Gemfields to hold auctions thus requires the lifting of worldwide travel restrictions to the extent required to allow movement of both stones and customers between countries.

As previously guided, Gemfields held just one gemstone auction in the first half of the year with no May/June auctions held and H1 group revenue totalled US$15.0m (down 83% y-o-y). However, where previously the intention was to hold both emerald and ruby auctions in October, the company now intends to hold an HQ emerald auction and an MQ ruby auction in December. MRM presently has sufficient inventory to support one MQ ruby auction and Kagem presently has sufficient inventory to support one HQ and one CQ emerald auction. As such the planned December auctions are not dependent on the resumption of production by the fourth quarter.

Rising COVID-19 case numbers in a number of countries globally have seen renewed border closures and/or quarantine requirements recently, and thus as yet there is uncertainty as to when auctions may be held. The biggest risk for Gemfields currently is that significant travel restrictions still remain in place in December preventing auctions from being held this year.

Holding auctions in December rather than earlier in the quarter would also have a negative impact on closing net cash, as it is normal for a portion of auction revenues to remain as receivables for 30–40 days.

All but critical operations at MRM in Mozambique were suspended from 22 April 2020 and are now expected to remain suspended until at least 30 September. Employees not required for critical services have been placed on suspended contracts on reduced remuneration, as have MRM’s board of directors. This has reduced the overall MRM wage bill by 25%. In addition, other cost saving measures have been implemented, reducing cash operating costs from approximately US$2.6m per month in Q219 to circa US$1.8m per month in Q220. Additional cost saving measures recently implemented will further reduce cash burn at MRM. MRM has confirmed 10 cases of COVID-19 (the majority were asymptomatic), and quarantined the affected employees and their closer contacts.

Principal operations at Kagem Emerald Mine in Zambia were suspended from 30 March 2020. The sort house was partially reopened in June 2020 to clear a backlog of sorting, grading and referencing of emeralds. Mining is expected to remain suspended until at least 31 October 2020. Employees not involved in the ongoing delivery of critical services have been placed on reduced remuneration since May 2020, which has reduced the overall wage bill at Kagem by approximately 20%. In total Kagem’s cost saving measures have resulted in cash operating expenditure being reduced from US$3.4m per month in Q219 to US$1.3m per month in Q220. No cases of COVID-19 have been confirmed on site. However, the company is alert to the risk posed by the significant recent rise in COVID-19 cases in Zambia, and particularly in the Copperbelt region.

Fabergé’s direct retail operations at Harrods and in Houston were closed in March but have now reopened, as have the partner-operated monobrand stores in Dubai and Kiev. Most of Fabergé’s multibrand customers have also re-opened and Fabergé is starting to see signs of gradual market recovery. H1 revenues were down 34% y-o-y to US$2.5m. Fabergé has reduced operating costs to US$1.7m in the quarter to June 2020 (versus US$2.4m in Q219).

Gemfields ended 2019 with cash of US$78.2m and net cash of US$25.4m and despite the precipitous fall in revenue in the first half, the company still had cash of US$53.6m and net cash of US$9.3m at the end of June 2020, and the company has a further US$15.6m in undrawn debt facilities. That strong balance sheet position means that Gemfields remains well placed to weather the COVID-19 storm over the remainder of this year. Gemfields has also responded rapidly to cut costs, both at its mines and Fabergé as described above, and also centrally with London employees moved to a four-day week since May. Overall, group monthly cash costs have been reduced from US$12.1m across 2019 to less than US$5m in June 2020 (average monthly cash costs were under US$7m in H120).

Nevertheless, as Gemfields notes in its announcement, if hosting gemstone auctions by the end of December 2020 is unviable, additional cash maintenance measures will be implemented and the company may need to consider its options to raise additional capital.

In our April note (Still good value under varied COVID-19 scenarios) we considered three possible scenarios for the potential impact of COVID-19 on Gemfields. Our ‘central case’ expected that travel restrictions would ease to the extent required to allow two full-sized emerald (one CQ and one HQ) and one MQ ruby auction in early Q4. While Gemfields still hopes to hold auctions in December, these are now likely to be more selective (smaller) sales. With the global economy still suffering significant disruption from COVID-19 even as we move into the latter part of the year, we also think it now more likely that there will be a longer-term impact on gemstone demand and thus pricing (in line with our previous slower recovery case, which had assumed a 15% reduction in 2020 pricing and a 10% longer-term drop relative to pre-COVID-19 prices). Taking these factors into account, we now forecast 2020 group revenue of US$62m (vs US$102m previously in our central case and US$53m in our slower recovery case).

However, the extended suspension of operations at MRM and Kagem, as well as cost-cutting measures, mean that costs have been reduced more than previously envisaged in either our central or slower recovery cases. Capex has been deferred and we now forecast capex of US$10m against US$16m previously. We now expect Gemfields to end 2020 with net debt of US$11m compared to a previous forecast of net cash of US$4m in the central case and US$21m net debt in our slower recovery scenario.

Our longer-term forecasts are broadly in line with our previous slower recovery scenario, other than minor changes to revenue to reflect a slightly slower start to 2021 and the impact of lower inventory starting balances.

As previously, we value Gemfields using a discounted cash flow sum-of-the-parts model (at a 10% discount rate):