Gemfields Group — Maxi-mini auction results

Gemfields’ March and April 2021 ruby and emerald mini-auctions generated sales of US$90.3m – a very positive result not only considering the limitations of the alternative process but also in absolute terms. Pricing at both auctions was very strong, albeit impacted by the mix of stones sold. The success of the mini auctions shores up the Gemfields’ balance sheet and points to very solid market demand for Gemfields high quality ruby and emerald production from MRM and Kagem.

Between 15 March and 8 April Gemfields held a series of seven ruby mini-auctions consisting of mixed quality-rubies mined at MRM prior to suspension of operations there in April 2020. Stones were made available for viewing in Bangkok, Dubai and Jaipur and then auctions took place via an online platform.

The ruby mini-auctions generated:

Production has resumed at MRM and is expected to ramp up to full capacity by the end of April. The company hopes that the next mixed-quality auction will take place late this year.

MRM is located 280km from the town of Palma (the location of recent insurgent attacks) in Mozambique. While not affected by the conflict directly, Gemfields is closely monitoring the situation and working with the government to provide humanitarian relief for the many thousands of displaced people.

Between 15 March and 17 April five emerald mini-auctions were held of high-quality emeralds mined at Kagem prior to suspension of operations there in March 2020. Stones were made available for viewing in Tel Aviv, Dubai and Jaipur followed by auctions via an online platform.

The emerald mini auctions achieved:

Production has resumed at Kagem and is expected to ramp up to full capacity by the end of April.

In our December 2020 note we calculated that Gemfields should not need to raise additional capital provided that full emerald and ruby auctions could be held in March 2021 or soon thereafter. Despite not being able to hold full in-person auctions at all in H1, the mini-auction results have exceeded the US$70-80m figure that we had expected for full in person auctions with total auction proceeds of US$90.3m. We have increased our group full year revenue forecast to US$190.1m (from US$183.5m previously) to capture this strong auction result, partially offset by slightly lower inventory than available for sale in H2.

Operations at both Kagem and MRM resumed in March ramping up to full production by the end of April. That will increase Gemfields’ monthly cost base to around US$12m a month (from US$5m a month when these operations were on care and maintenance). Nevertheless, buffered with cash from the mini-auctions, Gemfields now has sufficient cash reserves to take the company comfortably through to the next planned auctions in late Q4. The chart below shows our updated forecast cash and net cash balances on a monthly basis. We now expect Gemfields to end 2021 with cash of US$50.4m and net debt of US$6.6m (from net debt of US$11.0m forecast previously).

The company continues to expect to return to its standard auction process in H2 (with auctions held fully in person in a single location to which customers travel), however the success of the recent mini-auctions means there is a clear fallback process if restrictions persist.

At 31 December 2020, Gemfields had cash of US$43.9m, and US$56.5m in borrowings comprising:

At December 2020 all facilities were close to fully drawn. In March 2021 BCI granted MRM a further US$8.9m facility to be repaid from the next auction proceeds (or within six months). On repayment, MRM will, with agreement from BCI, have access to a US$15m facility repayable over four years.

Where earlier this year there was a very real risk that Gemfields would need to look for additional funding to take it through this COVID-19 period, we believe that investors can now appraise the longer-term value proposition without concerns around nearer-term funding risk.

The impact of COVID-19 saw operations at Gemfields’ Kagem emerald mine in Zambia suspended in March 2020 followed by operations at the MRM ruby mine in Mozambique in April 2020. Operations remained suspended through the rest of the year and have only resumed in recent weeks at both operations. Perhaps more concerning for the company and investors, Gemfields was only able to hold one regular-format commercial quality emerald auction in February 2020 generating US$11.4m and thereafter was unable to hold regular auctions because customers were unable to travel internationally. In November and December, Gemfields held its emerald mini-auctions generating US$10.9 meaning that for the whole of 2020 the company generated just US$22.3m in auction revenues against US$200.5m in 2019. Fabergé was also not immune from the impact of COVID-19 with a number of outlets closed during the early stage of the pandemic and sales falling to US$7.1m from US$10.5m in 2019. Group revenue totalled US$34.6m, down 84% year-on-year.

The company cut costs dramatically in response, with total cash mining and production costs reduced from US$63.4 in 2019 to US$37.7m in 2020, and SG&A falling from US$51.7m in 2019 to US$27.8m in 2020. Nevertheless, Gemfields saw a 2020 EBITDA loss of US$30.0m in 2020 against an EBITDA profit of US$80.9m in 2019.

Gemfields’ 2020 results also reflect write-downs of US$13.5m relating mainly to Fabergé intangible assets and inventory. The group also took a US$27.9m fair value loss on its 6.54% stake in Sedibelo. The stake in Sedibelo is non-core for Gemfields and it has engaged advisors to look for buyers for this holding, but the indirect holding structure (through a 23.65% equity holding in a Luxembourg holding company, Pallinghurst Ivy Lane Capital) complicates the investment proposition for potential purchasers. The management of Pallinghurst Ivy Lane Capital has indicated its intention to unbundle the holding, which could benefit the sale process.

Gemfields reported a 2020 loss before tax of US$99.2m (2019 PBT of US$67.4m) and loss per share of US$0.07 (2019 EPS of US$0.02).

As the months of continued COVID-19 travel restrictions continued, earlier this year we had begun to fear that our 2021 forecasts for Gemfields may prove optimistic if the company could not hold auctions in H1. However, the success of the mini-auctions has put those fears to rest and our 2021 forecasts reflect only relatively minor changes compared to our previous forecasts including a US$7m increase in forecast revenue following the strong mini-auction results.

We now forecast 2021 EBITDA of US$33m (previously US$29m), PBT of US$1m (US$2m previously with the difference explained by higher forecast depreciation)) and closing net debt of US$6.6m (previously US$11.0m net debt).

In addition to the normal operational, safety, environmental and other risks of any mining operation, Gemfields has two key risks currently that we think investors should pay particular attention to, being heightened political and security risks in Mozambique and coloured gemstone market risk.

Since 2017, there has been a rise in insurgent attacks in the Cabo Delgado region in 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 escalated through 2020 and it is estimated that some 700,000 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.

While the success of the March/April mini-auctions indicated a strong market for coloured gemstones, the strength of those results reflected in part pent-up demand as no ruby auctions were held by MRM at all in 2020, while Kagem sold just US$10.9m in high-quality emeralds (and US$11.4m in commercial-quality emeralds in February 2020). Whether coloured gemstone market demand will remain strong, particularly given continued COVID-19 risks in India, which is a key emerald cutting and polishing market, remains a key risk for the company.

As previously, we value Gemfields on a discounted cash flow sum-of-the-parts basis (at a 10% discount rate). Our updated valuation reflects a valuation date and net cash balance as at 31 December 2020 (previously 31 December 2019).

With our forecasts little changed, the key change to our valuation reflects this rolling forward of the valuation base date.