Is Gem Diamonds Limited A Better Buy Than BHP Billiton plc After This Morning’s Results?

Shares in diamond miner Gem Diamonds (LSE: GEMD) shot 10% higher this morning, after the group beat profit forecasts and announced a 2.5p special dividend.

Although revenue fell by 8%, adjusted earnings per share rose 26% to 30.2 US cents, or around 21p. This is significantly higher than forecasts of about 15p per share, and puts Gem Diamonds’ shares on a modest trailing P/E of 5.2.

There’s good news on dividends, too. Last year’s 5 cent per share dividend payment was maintained, but the payout will be boosted by a 3.5 cent per share special dividend. This will be funded using money from a tax settlement. The two payouts mean that at current share prices, Gem shareholders will enjoy a yield of 5.5% this year.

Still got problems

One of the keys to Gem Diamonds’ success in last year’s slower diamond market was the quality and size of the stones produced by its Letšeng mine in Lesotho.

This mine produces some of the largest and best quality diamonds in the world. Since 2006, when Gem Diamonds took over, Letšeng has produced four of the 20 largest white gem quality diamonds ever recorded.

However, Gem Diamonds’ other mine, Ghaghoo, produces more ordinary diamonds. Poor market conditions and some technical challenges meant that Ghaghoo generated sales of just $14.4m last year. The mine’s costs were much higher, however, at $39.2m.

The resulting net loss from Ghaghoo was about $25m. This doesn’t show up in Gem’s profit and loss statement because the mine was not considered to have reached commercial production last year. Instead, these costs were added to the value of the Ghaghoo assets on Gem’s balance sheet.

This is a legitimate way of accounting for such costs, but it does mean that Gem Diamonds’ reported profits last year did not result in positive cash flow. The firm’s cash flow statement shows a $25m net outflow of cash last year, despite reported profits of $77m.

The Ghaghoo losses meant that Gem’s net cash fell from $73.6m to $55.3m last year. The firm confirmed today that one of its top priorities for 2016 is to restructure Ghaghoo operations in order to reduce cash consumption.

Gem Diamonds currently trades on a 2016 forecast P/E of just 6.5. This looks reasonable value, as long as Ghaghoo’s cash consumption can be reduced. I’d rate the stock as a cautious buy.

Better returns from BHP?

Big mining stocks have delivered a strong performance so far this year. Shares in mining giant BHP Billiton (LSE: BLT) have risen by nearly 200p from their January low of 580p.

However, BHP recently announced a change to its dividend policy that’s expected to result in this year’s payout falling by more than 60%. Although the cut was prudent and sensible, the firm’s reputation as a super-reliable dividend stock has been tarnished.

Despite this, I’d argue that now could be a good time to take a fresh look at BHP. Profits are expected to hit a low of $1,093m this year, before rising to around $2,500m in 2017. With the shares still offering a forecast yield of almost 4%, now could be a good time to buy for a long-term holding.

Gem Diamonds and BHP both offer the potential for gains, but dividends payments could fall if commodity prices fail to improve.

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Roland Head owns shares of BHP Billiton. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.