The Crown Jewel: Gemfields' Dominance in the Gemstone Market

An equity research report on precious gemstone miner Gemfields

Part I About the Company

Gemfields is a leading supplier of responsibly sourced coloured gemstones, operating in both the side mining and the marketing side of precious stones. The company was founded in 2007 and is headquartered in London. Gemfields is listed on the JSE under the ticker symbol GML and has a market capitalisation of R5 billion.

Gemfields' primary focus is on the mining of emeralds in Zambia and rubies in Mozambique. The company is committed to ethical and sustainable practices and works closely with local communities to ensure that its operations benefit both the environment and the people living in the area.

Gemfields also owns the luxury jewellery brand Fabergé. Through ownership of this prestigious brand of exceptional heritage they are able to optimise positioning, perception and consumer awareness of coloured gemstones. Fabergé are also well known for there for imperial Fabergé eggs which were created between 1885 and 1916 and were prized possessions of Russian oligarchs.

The gemstones mined by Gemfields are sold through  auctions, which are open to authorised buyers from all over the world. The company has a strong reputation for the quality and integrity of its gemstones, and its auctions are highly regarded in the industry. Gemfields also partners with designers, manufacturers, and retailers to create unique and exclusive collections of jewellery featuring its gemstones. By doing so, Gemfields aims to promote the beauty and desirability of coloured gemstones to a wider audience.

When I think of Gemfields, I see them as the luxury player in the mining industry. Similar to the way LVMH and Richemont are luxury players in the fashion industr  y. You might be wondering who Gemfields customers that are purchasing these precious gemstones at auctions. Gemfields sells directly and indirectly to high-end jewellers including Cartier, Fabergé, Montblanc, Tiffany & Co and Van Cleef & Arpels. Gemfields operates in a niche space by focusing on precious gemstones and are one of very few players operating in this niche. Some other notable players that focus predominantly on diamonds include Rio Tinto and De Beers.

Gemstones unlike commodities such as gold, platinum or iron ore do not have a spot prices. This is because no two gemstones are the same and thus the need to the price to be determined on auction between market participants (excuse the IFRS 13 jargon). So, you may be wondering what factors actually influence the price of a precious gemstone. The key factors are:

Rarity: The rarity of a particular gemstone is one of the primary drivers of its price. If a gemstone is scarce or difficult to find, it will generally be more valuable.

Quality: The quality of a gemstone, including its colour, clarity, and cut, can have a significant impact on its value. Gemstones that are free from blemishes and inclusions, and have a vivid colour and excellent cut, are typically more valuable than those that are of lower quality.

Size: The size of a gemstone can also affect its price. Larger gemstones are generally more valuable than smaller ones, although this is not always the case if the smaller stone has exceptional quality or rarity.

Supply and demand: Like any commodity, the price of gemstones is also affected by supply and demand. If demand for a particular gemstone is high, and the supply is limited, the price will typically increase. Conversely, if demand is low or the supply is plentiful, the price may decrease.

Market trends: Trends in fashion and consumer preferences can also influence the price of gemstones. For example, if a particular gemstone becomes fashionable or popular for use in jewellery, the price may rise.

Part II Gemfields Mines

Gemfields is the 75% owner and operator of the Kagem emerald mine in Zambia and Montepuez Ruby Mining (MRM) in Mozambique. The company works closely with local partners who own the remaining 25% of the mining operations. In Zambia the Company partners with the Zambian government the Industrial Development Corporation (IDC). In Mozambique Gemfields are partnered with a local company Mwiriti Limitada.

 The mining process varies slightly between emeralds and rubies, but both are mined in open pits without any tunnels. Open but mining is far less cost intensive and also safer for mine workers. In Zambia, emeralds are found underground in hard rock. In the Companys biggest pit, emeralds are recovered from 140 meters deep. The mining process involves blasting away waste rock, experts extract emeralds from the lower-level hard rock with chisels and then these gemstones are taken to a washing and sorting plant.

In Mozambique, rubies are found in loose, muddy gravel, relatively close to the surface. The ruby-bearing gravel is scooped up and washed thoroughly, after which the gravel is sorted.

Gemstones are sorted in a sort-house, where stones are graded using a propriety grading system. The rough emeralds and rubies are then offered at private auctions to vetted partners with proceeds fully repatriated to the host nation.

Part III - Operational Overview

To date the Kagem mine and MRM mine have fetched cumulative action revenues of USD899 million and USD898 million respectively. For the 2022 financial year ending 31 December 2022 Kagem generated revenue of USD149 million (44%), MRM generated revenue of USD167 million (49%), and Fabergé generated revenue of USD18 million respectively (5%).

Both Kagem and MRM typically have two auctions per year, so revenue is difficult to track on shorter time frame than biannually. Both Kagen and MRM operated at very high EBITDA margins of 49% and 50% in the most recent financial period. The Fabergé brand however appeared to be the bad egg of the bunch with a negative EBITDA margin of 8%.

In terms of market share Kagem makes up approximately 25% of global emerald supply while MRM makes up around half of global ruby supply. The current life-of mine for Kagem is further 22 years up until 2044 while MRM is 8 years to 2030. Management of the Company is confident that through further exploration the life-of-mine will be extended in future. MRM is expect to operate a fully capacity by 2026.

Part IV Financial Performance

Since 2009, Gemfields has held 61 auctions (43 of Zambian emeralds and 18 of Mozambican rubies), surpassing USD1.8 billion in combined auction revenue. 2022 saw record auction revenues and prices paid for both emeralds and rubies as the attractiveness and value of coloured gemstones continue to grow. Fabergé also saw record revenue and is approaching profitability as an entity.

Gemfields is a profitable business, with strong growth in EBITDA and profit after tax in 2022. At the end of 2022, the Group had a record-high net cash position of USD105 million, with a further USD55 million of outstanding auction receivables. The Group also owns 6.54% of Sedibelo Resources Limited, valued at USD32 million in 2022. This holding is non-core and Gemfields is looking to exit the investment which should further increase the cash position of the entity.

The Company has grown total revenue at a compounded annual growth rate (CAGR) of 10.61% since 2018. EBITDA has growth at an impressive CAGR of 23.29%. Free cash flow, arguably the most important metric has grown at a CAGR of 29.88%.

The revenue and earnings of the company has been stable and growing with the exception of 2021 where mine operations had to be suspended as a result of COVID-19 causing operational shutdowns.

Gemfields management has a new set of capital allocation priorities, with a focus on maintaining debt, organic and inorganic investment, and returning capital to shareholders. In 2022, Gemfields paid its first and second ever dividends, with a total of USD35 million returned to shareholders.

The Board have approved a further USD35 million dividends to be paid on 12 May 2023, representing USD cents 2.886 per share. A USD10 million share buy-back was approved by shareholders in November 2022, with no shares currently purchased.

Part V Financial Statement Analysis

For the 2022 financial period Gemfields generated revenue USD341.11 million and a gross profit of USD180.25 million resulting in a gross profit margin of 52.84%. Operating profit for the year was USD116.54 million equating to an operating profit margin of 34.16%. Bottom line or net profit for the year was USD74.27 million with a resulting net margin of 21.77%. It is however important to note that only 75% of these profits are attributable to equity holders Gemfields with the remaining 25% going to non-controlling interests of Kagem and MRM.

The entitys total assets (USD774.13 million) exceed its total liabilities (USD193.03 million) resulting in a positive net asset value of USD581.1 million. The entity currently has a market capitalisation of R4.97 billion or approximately USD275.23 million and is thus trading at a large discount to net asset value.

The entity has a very healthy capital structure with little debt on the balance sheet. Borrowings to equity is only 2.41% while total liabilities to equity are 33.21% and indicative of a healthy capital structure. Liabilities to Assets is 24.93%

When looking at the liquidity position of the entity we can observe that they have cash of USD118.53 million which exceeds current liabilities of USD103.54 million. The following liquidity rations can be calculated from the balance sheet:

-       Current Ratio: 3.18

-       Quick Ratio: 2.11

-       Cash Ratio: 1.14

The financial position of the entity from both a liquidity perspective and solvency perspective are healthy, and the entity has enough dry to powder to either return capital to shareholders or seek new expansive investment opportunities.

For the 2022 period return on assets was 9.59% and return on equity was 12.78%.

Part VI Valuation

Gemfields is currently trading a price to earnings ratio 5.05, a price to free cash flow of 2.37 and a price to book of 0.56. The EV/EBIT ratio is currently 1.48 and the EV to EBITDA is 1.12. The trailing 12-month dividend yield is 25.43% and management have also started to buy back shares.

When looking at financial models on FinBox using EV/EBITDA multiples, P/E multiples and price to book multiples I derive a fair value range of R4.92 to R5.89, with an average fair value of R5.29. Based on the current share price of R4.10 the potential upside using this fair value estimate is 29%.

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