CA - Mountain Province Diamonds: Record Profitability In Q2 2022 But Funding Issues Are Unresolved

Summary

• In Q2 2022, the company booked record adjusted EBITDA of C$55.1 million ($42.2 million) as the average selling price was $130 per carat.
• Russia has been almost completely cut off from the main markets. I think diamond prices are likely to remain above $100 per carat in the foreseeable future.
• However, Mountain Province Diamonds has over $270 million of notes maturing in the middle of December, and it seems this is putting pressure on the share price.
• I’m optimistic that a solution favorable for investors will be found, but I think risk-averse investors should avoid this stock for now.

Introduction

In May 2022, I wrote a SA article about Mountain Province Diamonds ( MPVDF ) in which I said that I might consider investing in the company once it refinances its debt.

Diamond prices have been strong over the past few months, and this helped Mountain Province Diamonds book the highest quarterly EBITDA and earnings from mine operations in its history in Q2 2022. This enabled it to fund the repurchase and cancellation of $26.4 million aggregate principal amount of 8% senior secured second lien notes in July, but I'm concerned that the uncertainty surrounding the debt is pushing the market valuation down. Mountain Province Diamonds looks cheap based on fundamentals, and I'm optimistic that a solution favorable for investors will be found before the notes mature in December. Let's review.

Overview of the recent developments

In case you haven't read my previous article about Mountain Province Diamonds, here's a brief description of the business. The company owns a 49% stake in Gahcho Kué, which is the fifth-largest diamond mine on the planet, with an annual production of about 7 million carats. The project is located at Kennady Lake in the Northwest Territories, and the remaining 51% is held by global diamonds producer De Beers. The latter is the operator of the mine, but Mountain Province Diamonds has more than 107,000 hectares of claims and leases that surround the mine.

Gahcho Kué includes four primary kimberlite bodies and the remaining life of mine is about 8 years, but I think it's likely to be extended in the coming years as exploration results look promising. In Q2 2022, there were a total of 14 holes drilled at the Hearne Northwest Extension and there were intersections of kimberlite in 60% of them, with the longest intersection reaching 114.5 meters. Separately, Mountain Province Diamonds has embarked on a 6,000-meter drilling program on its own claims in 2022 and 3 out of the 4 target areas have kimberlite intersections after 3,000 meters of drilling. Overall, kimberlite has been intercepted in 16 out of 20 holes drilled, which I find encouraging. At the moment, the claims and leases of Mountain Province Diamonds include the Kelvin kimberlite and Faraday kimberlites, which are estimated to contain 13.62 million carats and 5.45 million carats, respectively.

Turning our attention to the production and financial performance of Mountain Province Diamonds, there was a noticeable operational improvement in Q2 2022 as ore tonnes treated increased by 6% compared to Q1 while carats sold rose by 16% and the ore stockpile soared by 28%.

While the average diamond recovery is still lower than a year ago, the company booked record adjusted EBITDA of C$55.1 million ($42.2 million) and earnings from mine operations of C$51.4 million ($39.4 million). The reason for this is that diamond prices remained high in Q2 as the market remains tight due to severely interrupted supply from Russia after the invasion of Ukraine. Most major retailers and industry bodies have now declared buying policies that ban the purchase of Russian diamonds. The company held 3 sales during the quarter and the average selling price was $130 per carat, with consecutive price increases at each sale.

The free cash flow in Q2 2022 stood at a healthy C$27.6 million ($21.1 million), which is a significant improvement compared to the C$14.7 million ($11.2 million) achieved in Q1 2022. This allowed Mountain Province Diamonds to complete a $25.3 million deal in late July that included the purchase and cancellation of $26.4 million aggregate principal amount of notes. Considering the notes were bought below par value, this seems like a good deal. However, there were around $273.5 million aggregate principal amounts of notes that remained outstanding after the transaction, and progress on the refinancing of these notes over the past few months has been limited. During the Q2 2022 earnings call , Mountain Province Diamonds said that it continues to be actively engaged in evaluating options to address the bonds, with a focus on the ones that are friendly to shareholders. Considering these notes mature on December 15, it seems likely that many investors are feeling nervous, and I think this is the main reason the share price of Mountain Province Diamonds has been declining over the past 5 months in spite of strong financial results.

So, what lies ahead? Well, the main owner of the notes is Irish billionaire Dermot Desmond who is also the largest shareholder of the company with a 35.4% stake. I'm optimistic that an investor-friendly solution will be found and that there won't be significant stock dilution as he has a good track record and helped the company keep itself afloat during the COVID-19 lockdowns through diamond purchases and debt restructuring. That being said, I prefer to wait for the notes to be refinanced before opening a position here as I think the share price could remain under pressure in the near future due to the uncertainty surrounding the debt.

Looking at the risks for the bull case, I think there are two major ones. First, I might be too optimistic about the chances of refinancing the December 2022 notes at favorable rates. It's possible that Mountain Province Diamonds runs into liquidity issues in less than four months and this could lead to significant stock dilution. Second, the lifting of bans on diamonds coming from Russia could create a glut in the market and this would lead to much lower diamond prices. It's impossible to predict how the conflict in Ukraine will unfold and how much time it will take for Russia to be taken off blacklists in different markets.

Investor takeaway

Russia is a major diamond supplier but has been almost completely cut off from the main markets due to the invasion of Ukraine and this has pushed up diamond prices. It doesn't seem the situation is likely to change anytime soon, and I think diamond prices could remain above $100 per carat in the foreseeable future.

Non-Russian diamond producers like Mountain Province Diamonds have been reaping record profits over the past few months, but the market valuation of the company has been sliding since the end of March. Mountain Province Diamonds has over $270 million of notes maturing in the middle of December, and it seems this is putting pressure on the share price. In my view, the notes are likely to be refinanced at favorable terms in the near future as their main owner is the major shareholder of Mountain Province Diamonds, and he has a good track record of acting in the best interest of investors. However, I think that risk-averse investors should avoid this stock for now as the share price could decrease significantly before a deal is announced.

According to a technical report from March 2022, the after-tax net present value ((NPV)) attributable to Mountain Province Diamonds stands at $759 million, so there is value to be found here.

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