Petra Diamonds is now a significant producer in waiting say its directors, who've reshaped the company in the face of market turmoil and backed the strategy with their own cash…
Three directors at Petra Diamonds (LSE: PDL) recently spent £1 million on shares in the AIM-listed miner.
Should we care? There's no conclusive evidence that following directors trading in their own shares will make you money.
In theory, directors know their sector and company backwards, and so may spot a bargain before other investors. But there's nothing to stop them believing their own hype, and making bad investments like the rest of us. Any truly price sensitive information has to be declared -- there's a courtroom of difference between director dealing and insider dealing.
And if academics did prove that following director's trading was a sure route to profits, the opportunity would vanish faster than you can say 'Efficient market hypothesis'.
Directors dive in
Still, what investor wouldn't want to see directors backing their own abilities?
Petra Diamonds' chairman Adonis Pouroulis, finance director David Abery and non-exec Charles Segall purchase certainly pressed the right buttons.
The three directors paid 22p a share on 9 April to acquire 1,378,122 shares each, at a cost of £303,187 per director. It's already proved lucrative -- the shares touched 40p yesterday, before falling back to 36p, which values Petra at £66.5 million.
At least a few Petra investors presumably believe the directors are on to something. But the company's share price has also risen with other junior miners, where a modest April rally on greater confidence and firming commodity prices has followed sector wide falls of 75% or more in the past year.
Futile adventures in Angola
Petra's directors would argue their bold action in the face of this turmoil has transformed the company's prospects.
It's certainly change the investment story. Today, Petra is on track to produce 1 million carats of diamonds a year by June from five mines in South Africa, and one in Tanzania.
In contrast, a couple of years ago investors pinned their hopes on substantial exploration projects in Angola. But Petra announced in December it was giving up the Angolan Alto Cuilo project it originally undertook with BHP Billiton (LSE: BLT). In February it scaled back its other exploration ventures, with only a couple of small interests left ongoing. Abandoning exploration will save Petra $25 million a year -- at a cost.
The company posted a net loss of $88 million for the six months to December, compared with a profit of over $8 million for the same period the year before. Much of the loss arose from a $75 million impairment charge against the exploration ventures.
Cash in the bank fell from $59 million to $10 million on exploration and acquisition costs. With external funding for risky exploration having vanished with the credit crunch, Petra had to curb its ambitions.
Producing a profit
The investment case now hinges on Petra's ability to produce diamonds efficiently, with big profits geared to a recovery in diamond prices.
The six mines Petra operates were largely acquired from the majors. Petra believes with careful management and extraction the mines have plenty of life left in them, as evidenced by two splendid blue diamonds recently recovered from its Cullinan mine, including a 39.19 carat diamond sold for $8.8 million.
As for margins, in its interim results Petra said the South African mines were now cash flow positive.
De Beers, the diamond giant, said this month that diamond sales are increasing, after steep falls in 2008 due to the U.S. recession. The majors have slashed production, which should help support diamond prices and relative minnows like Petra.
Unlike gold, say, there's no spot price for diamonds, and the value ascribed to the resources at each of Petra's mines ranges from $90 per carat at the giant Cullinan mine to over $400 per carat at the smaller fissure mines.
If Petra achieves its aim of 1 million carats a year at these prices, revenues north of $90 million are clearly achievable. It's hard to judge the effect on profits, given the huge changes in Petra's business since the last full results. However it would very likely see the company swing back into the black.
The long-term case for diamonds hinges on dwindling reserves -- there are just 20 years' supply left in the ground -- meeting rising demand from emerging markets. Petra claims to have attributable reserves of 120 million carats, so though a small player it potentially has billions of dollars worth to extract.
A sparkling investment?
The commodity boom isn't likely to resume any time soon, and having spent those years hunting for diamonds, Petra is now a producer in the midst of a slump.
However their £1 million investment says the directors believe in the transformation. They already had a substantial personal stake in its success. Chairman Adonis Pouroulis held nearly 8 million shares before his latest purchase, and options granted to the directors and re-priced in March cover 3.5% of the issued share capital.
The previous options were exercisable starting at 125p a share, which apparently didn't offer much incentive to directors. The new excise price of 27.5 pence puts the frustration back on long-term investors. Petra was trading at 116p a share a year ago.
Still the directors aren't responsible for the global downturn. If you believe in a U.S. consumer recovery and the long-term case, Petra may be worth a flutter. With $10 million in the bank and slim margins though, there's not much room for error.
Note that a single Saudi-based fund owned 44% of Petra as of December, but as a Bermuda registered company, Petra is not subject to usual mandatory takeover offer. The investor's substantial holding will reduce liquidity, however.
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