CA - Mountain Province Diamonds: Robust Q4 Production Debt Issues Resolved (Rating Upgrade)

Summary

• In Q4 2022, the Gahcho Kué diamond mine produced over 1.6 million carats and I expect the company’s operating income to be above $15 million.
• On December 15, Mountain Province Diamonds completed the refinancing of its debt thus avoiding significant stock dilution.
• I expect the company’s valuation to gradually increase to about 1x NPV which is equal to $1.80 per share.

Introduction

In November 2022, I wrote a bullish article on SA about Canadian diamond miner Mountain Province Diamonds (MPVDF) in which I said that it booked strong results for Q3 2022, and that diamond prices remained high. In my view, the bull case seems stronger today as Mountain Province Diamonds has refinanced its debts and Q4 production surpassed 1.6 million carats. I was expecting the closing of the debt refinancing deal to be a major catalyst for the share price, but the market valuation has barely changed over the past two months. In my view, this could be a good window of opportunity to open a small position. Let's review.

Overview of the recent developments

In case you haven't read any of my previous articles about Mountain Province Diamonds, here’s a quick description of the business. The company’s main asset is a 49% stake in the Gahcho Kué diamond mine in the mining friendly Northwest Territories in Canada. The project is located near the Diavik and Ekati diamond mines and used to be the fourth largest diamond producer in the world before the COVID-19 pandemic with an annual output of about 7 million carats. The remaining 49% of Gahcho Kué is owned by De Beers.

According to a technical report from March 2022, the after-tax net present value ((NPV)) attributable to Mountain Province Diamonds stands at C$964 million ($724 million). The mine life ends in 2030 but I expect it to be increased significantly as mineralization remains open at depth. In addition, Mountain Province Diamonds has more than 100,000 hectares of claims and leases that surround the project where it has already found three notable deposits with combined indicated and inferred resources of almost 21 million carats.

Turning our attention to the latest production figures, Gahcho Kué’s output for Q4 2022 came in at 1,621,800 carats at an average grade of 1.96 carats per tonne. This represents an increase of 11.7% compared to Q3 and the mine’s production is now almost at pre-pandemic levels. The total output for 2022 stood at 5.52 million carats which means that Gahcho Kué came just short of meeting the 2022 production guidance, but I think few investors were expecting it to meet the guidance considering the poor start of the year.

Diamond prices are declining but they continued to be high as supply from Russia remains disrupted and Mountain Province Diamonds managed to sell 757,830 carats an average value of $94 per carat in Q4. This means that revenues for the quarter stood at $71.3 million, which represents a 14.4% slump quarter on quarter. Overall, I expect Q4 operating income to remain above C$20 million ($15 million).

Looking at the long-term picture, Mountain Province Diamonds said that there’s a growing preference for smaller, lower priced diamonds in the U.S. market which is in line with the diamond profile of Gahcho Kué. Yet, I’m a little disappointed by the 2023 production guidance as it was set at between 5.6 million to 6.1 million carats. I was expecting this figure to be around 6.5 million. Production costs are expected to be between C$70 ($53) and C$80 ($60) per carat recovered, which is in line with the figures achieved in 2022.

In my view, the major risk for the bull case at Mountain Province Diamonds was the company’s debt profile as there were notes with an aggregate principal amount of $258 million expiring on December 15. However, the debt has been successfully refinanced since my last article as Mountain Province Diamonds exchanged $190 million aggregate principal amount of existing notes for around $195.9 million aggregate principal amount of new notes with a three-year term on December 15. The new notes were issued at 97% of face value and have a coupon of 9% per year which is 100 bps above the previous ones, but I consider this transaction to be a major positive development as it helped the company avoid significant potential stock dilution or even insolvency. On the bright side, interest payments will be lower as Mountain Province Diamonds reduced its total debt by about $60 million year on year as the remaining December 2022 notes were retired using cash on hand.

Overall, 2022 was a transformative year for Mountain Province Diamonds as production at Gahcho Kué gradually ramped up to pre-pandemic levels and an updated 43-101 technical report on the Gahcho Kué added almost C$400 million ($300 million) to the NPV post tax and royalties. The debt uncertainty issues have been resolved and I expect the company’s valuation to gradually increase to about 1x NPV considering diamond prices remain elevated and the mine life could be extended significantly over the coming years.

Looking at the risks for the bull case, I think that the major one at the moment is that the end of Russia’s invasion of Ukraine could lead to an oversupply in the market. This would put significant pressure on diamond prices. It’s also possible that high inflation rates lead to lower demand in major global markets such as the USA and Europe.

Investor takeaway

In my view, everything went right for Mountain Province Diamonds in 2022 and Gahcho Kué’s annual output is now about 6 million carats. There is still room for improvement, but I think that Mountain Province Diamonds is a strong buy now that the debt issues have been resolved. The company is currently trading below 3x TTM earnings and diamond prices remain high. According to the latest corporate presentation of Mountain Province Diamonds, the NAV per share following corporate adjustments is C$2.40 ($1.80) (see slide 18 here ) and I expect the share price to gradually move close to that level during the coming months.

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