Gemfields Group — Marching towards March 2021 auctions

Gemfields ordinarily 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 emerald auctions (February and August, usually in Lusaka) and two mixed-quality ruby auctions (June and December, usually in Singapore). The practical challenge is that these auctions rely on customers travelling from multiple countries to carefully inspect the stones and determine the value of their bids, which has not been possible since February.

In response to this significant challenge and to fulfil customer demand for certain specific grades of emeralds, Gemfields held five mini-auctions in November and December where selected lots were made available for in-person and private viewings by customers in Tel Aviv, Singapore and Jaipur and then the auctions took place via a specially adapted online auction platform. In total, the five mini-auctions generated US$10.8m in sales, from the sale of 0.18Mcts.

While the average price achieved of US$59.84/ct was well below that of the December 2019 auction of US$85.26/ct, this reflects more the specific selection of stones offered for sale that any market weakness. All indications are that the mini-auctions attracted solid demand, with 47 companies placing bids and 86% of lots sold. Gemfields commented that ‘prices remained robust and in a number of instances comfortably exceeded bids received in pre-COVID-19 auctions’.

Following the conclusion of the mini-auctions, Gemfields still holds sufficient high-quality emerald inventory to undertake a full-scale, high-quality auction in Q121, which is the company’s intention, provided that travel restrictions lift sufficiently to allow it to take place.

For Gemfields to hold full-scale, in-person auctions requires the lifting of worldwide travel restrictions to the extent required to allow movement of both stones and customers between countries. In our August note (Cash preservation ahead of December auctions) we based our forecasts on the assumption that Gemfields would be able to hold ‘near-normal’ if slightly smaller HQ emerald and ruby auctions in December 2020. However, a second wave of COVID-19 in many countries including Europe and the US has meant international travel restrictions have not eased to the extent that would have been required for auctions to be held in Singapore this year and auctions are now planned by the company for March 2021. The company already holds sufficient gemstone inventory for these auctions and does not plan to resume mining operations until March 2021.

Exhibit 1 summarises our forecast key metrics updated to reflect the delay in gemstone auctions until March 2021 and the continued suspension of mining operations at both Kagem and Montepuez Ruby Mining (MRM) until March 2021. We also reflect the US$26.6m in write-downs taken at the H1 results.

We now expect Gemfields to end 2020 with cash of US$48m (previously US$32m) with our cash flow forecast assuming the drawdown of a further US$15m in asset-backed financing at MRM. We forecast closing 2020 net debt of US$12m (previously US$11m). The very minor change in 2020 net debt compared to our previous forecasts reflects the significant actions the company has taken to reduce costs, including the continued suspension of the mines. In addition, in our previous forecast around half of the then anticipated proceeds from the December auctions would have been received in cash in early 2021, hence the US$32m reduction in forecast FY20 revenue translates to a c US$16m reduction in cash proceeds received in 2020 and then this is largely offset by cost savings.

For FY21, we now forecast EBITDA of US$29m (US$55m previously) and expect Gemfields to end the year with net debt of US$11m (previously US$1m).

Gemfields ended June 2020 still in a strong balance sheet position with US$9.3m in net cash. However, operating costs currently total US$5m a month and until meaningful auctions can be held this must be funded from the balance sheet. Investors may rightly be wary about pressure on Gemfields’ balance sheet until there is more certainty around auction timing. However, our analysis suggests that if auctions can be held in March as planned, Gemfields has sufficient funding headroom. However, if auctions cannot be held in March (or within a few months thereafter), the company may need to seek additional funding. In particular, Gemfields explicitly states in its H1 results that in the absence of auction sales it would require further funding in Q321 in the form of additional bank lending, an asset sale programme of non-core assets and/or fund-raising through a potential rights issue.

The table below summarises Gemfields’ debt facilities. At 30 June 2020 Gemfields had a total of US$44.4m in debt with a further US$15.6m in available undrawn facilities.

Kagem has long-term debt facilities totalling US$30m (fully drawn as 30 June 2020) secured against the assets of Kagem:

The Kagem facilities are subject to the following financial covenants:

Kagem has received a waiver of covenants.

In addition to the Kagem debt, at 30 June 2020 MRM had a total of US$30m in unsecured overdraft facilities of which US$15.6m was undrawn. These facilities are renewable annually with the ABSA Mozambique facility due for renewal shortly. Management expects these facilities to be renewed in the normal course of business.

In addition to its overdraft facilities, MRM is seeking to finalise a new US$15m financing lease facility. If secured, these facilities would provide further cash headroom at MRM until auctions can be held and operations resume in 2021.

Gemfields ended June 2020 with cash of US$53.6m and net cash of US$9.3m, which had moved to a net debt position of US$3.2m as at 11 September 2020 (Gemfields H120 results).

In response to the COVID-19 pandemic and the inability of the company to hold rough emerald and ruby auctions, Gemfields has taken significant steps to manage its costs and cash burn and has reduced operating costs from 2019’s monthly average of US$12.1m a month to under US$5m a month in June, including through the suspension of mining and processing at Kagem and MRM and all UK staff members including executive directors moving to a four-day working week for a 20% reduction in remuneration. The chart in Exhibit 3 illustrates our forecast Gemfields cash and net debt balances on a monthly basis through to the end of 2021, assuming that:

These assumptions and the closing 2020 and 2021 cash and net debt balances are in line with our annual profit and cash flow forecasts.

As the chart shows, our analysis suggests the company remains well placed to continue to meet its financial obligations through 2021, without the need for any further capital raising, provided that emerald and ruby auctions can be held as planned in March 2021 (or within a couple of months thereafter). Our analysis does not take into account potential proceeds from the planned sale of Gemfields’ stake in Sedibelo Platinum.

However, even assuming that auctions take place as planned in March 2021, it may be that Gemfields will need to ask Kagem lenders to waive the June 2021 covenant test, or otherwise refinance that facility with alternative debt funding given that the lack of auctions in H220 will have a significant negative impact on rolling 12-month financial metrics.

We forecast year end 2020 cash of US$47.8m and net debt of US$11.6m. For December 2021 we forecast closing cash of US$46.4m and net debt of US$11.0m. H2 auctions being held earlier than usual in the year could positively affect working capital flows as our forecasts assume that US$30m in auction receivables will be outstanding at the end of December 2021.

We believe the two key risks facing Gemfields are the continued inability to hold emerald and ruby auctions while international travel restrictions remain in place (which if not resolved before March 2021 would put Gemfields under significant balance sheet pressure) and the escalating insurgent violence in northern Mozambique where Gemfields’ MRM mine is located.

Our analysis shows Gemfields remains adequately funded with sufficient balance sheet headroom provided that normal in-person gemstone auctions can resume in March 2021, comprising one full HQ emerald and one mixed-quality ruby auction. However, as noted in Gemfields’ H1 results, if auctions cannot take place as planned or fetch lower than expected revenues or lenders withdraw their support then the group may require additional funding and would seek to secure additional bank lending, pursue an asset sale programme of non-core assets and consider, should it become necessary, fund raising through a potential rights issue.

Since 2017, there has been a rise in insurgent attacks in Cabo Delgado Northern Mozambique, where Gemfields’ MRM mine is located. The insurgents are linked to Islamist militant groups with connections to Islamic State but are also tapping into local political grievances. Those attacks have escalated through 2020 and it is estimated that some 400,000 civilians have been displaced by the violence. While the Montepuez region itself has been less affected and Gemfields operations have not been directly affected, the growing security crisis in this region is a key risk for Gemfields.

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