宝石策略手册：近期价格压力和结构性阻力

GlobalResearch8February2019

TheDiamondsPlaybook

UBSEvidenceLabinside:Near-termpricepressure

andstructuralheadwinds

DanielMajor

Analyst

Notjustanotherdiamondprimer-differentiatedanalysis/viewsinthisreportdaniel.major@

+44-20-75683472

Wearemorecautiousvsconsensusondiamondsbecause:1)webelievediamond

MylesAllsop

jewellerydemandgrowthwilllaggloballuxuryspendanddiamondswillnot'growin

Analyst

linewithGDP*;2)UBSEvidenceLabsurveyssupportourviewthatsyntheticdiamondsmyles.allsop@

arelikelytogainsufficientmarketsharetonegativelyimpactnaturaldiamonddemand+44-20-75681693

growth;3)diamondminesupplyissettodeclinebutwebelievethedisruptiveimpactis

HugoBravery

overstated.WeinitiateonAlrosawithaSell(Link)anddowngradeAnglotoSell(Link).Analyst

hugo.bravery@

Outlook-Solidlong-termfundamentals,butheadwindslimitpriceupside+44-20-75687202

Inourview,thefundamentaloutlookfordiamondsissolidandourbasecaseisfor

JaySole

modestpriceupsideinroughdiamondpricesmediumterm.But,nearterm,wedonotAnalyst

seeanyclearpositivecatalysts.JewellerydemandinUSA/Chinaappearslacklustre,thejay.sole@

marketforlower-qualitystonesisoversupplied,andlow-qualityroughinventorybuiltin+1-212-7133559

2H18islikelytore-enterthemarketwhendemandrecovers,cappingupsideinHelenBrand,CFA

benchmarkpricesandnegativelyimpactingpricerealisationsforAlrosaandDeBeers.Analyst

helen.brand@

Willtheglobaldiamondjewellerymarketgrowin-linewithGDP?+44-20-75684395

UBSEvidenceLabstudieshighlightdiamondjewellerywillremainakeycategorywithinJulieZhuang,CFA

Luxurybutwebelievedemandgrowth(<2%CAGR)islikelytocontinuetolagLuxuryAnalyst

spend(〜4%CAGR),drivenbylowermarriagerates&relativeunderspendondiamondjulie.zhuang@

marketing.Inourview,diamonddemandmaynotgrow'in-linewithGDP'asmany+44-20-75671888

believe.UBSEvidenceLabsurveysindicatethatnaturaldiamondsarelikelytoremain

thecorecomponentofthejewellerymarketandwedonotbelievegrowthinsynthetics

willreducetotaldemandfornaturaldiamonds.But,inourview,themarketpotentially

underestimatestheimpactthatsyntheticshaveonnaturaldemandgrowth.Inourbase

case($5bnby2023E),theCAGRfornaturalroughdiamondsdemand(1.8%)wouldbe

30%lowerthangrowthinthebroaderjewellerymarket(2.5%)duetosynthetics.

Willamaterialcontractionindiamondminesupplydrivehigherroughprices?

Minesupplyislikelytodeclineoverthenext3years,mainlydrivenbytheexhaustionof

Argylein2021(11%byvolume,but2%byvalue).WeacknowledgeArgyle'sclosure

willimpactthelowerendoftheroughmarket,butbelievethedisruptiveimpactonthe

diamondmarketinvaluetermswillbemodestandispotentiallyoverstated.

Figure1:Estimateddemandgrowth(US$)2018-23CAGRFigure2:Syntheticjewellerypurchasesvsintentions

^JewelleryPurchasesJewelleryPurchaseIntentions

Source:DeBeers,Alrosa,PaulZiminsky,UBSestimatesSource:UBSEvidenceLab

/investmentresearch

ThisreporthasbeenpreparedbyUBSAGLondonBranch.ANALYSTCERTIFICATIONANDREQUIREDDISCLOSURESBEGIN

ONPAGE46.UBSdoesandseekstodobusinesswithcompaniescoveredinitsresearchreports.Asaresult,investorsshouldbe

awarethatthefirmmayhaveaconflictofinterestthatcouldaffecttheobjectivityofthisreport.Investorsshouldconsiderthis

reportasonlyasinglefactorinmakingtheirinvestmentdecision.

ContentsDanielMajor

Analyst

Ourthesisinpictures3daniel.major@

+44-20-75683472

Diamonds:4MylesAllsop

Analyst

Diamonds1016myles.allsop@

+44-20-75681693

Whatarediamonds?6

HugoBravery

Whataretheyusedfor?6Analyst

hugo.bravery@

Howaretheyproduced?6+44-20-75687202

JaySole

Demand:growthinlinewithGDP?8Analyst

jay.sole@

Industrialdiamonddemand16+1-212-7133559

Supply:Materialcontraction?17HelenBrand,CFA

Analyst

helen.brand@

SyntheticDiamonds21+44-20-75684395

Mid-stream:Keyshort-termpricedriver28JulieZhuang,CFA

Analyst

Inventories:Buildingagainin2H1831julie.zhuang@

+44-20-75671888

Pricing:Size/qualitydivergencein2H1833

Diamondmarketoutlook:36

Syntheticdiamondpresssnippets39

Diamondmining/Jewelleryexposure40

Majordiamondminers:40

Diamondminingjuniors:41

Diamondjewelleryretailers42

Diamondcomptable43

Ourthesisinpictures:

Figure3:Breakdownofdiamondjewellerydemand(US$)Figure4:Estimateddemandgrowth(US$)2018-23CAGR-

-USAandChinakeyregionsfordiamonddemandNaturalpolisheddemandgrowthtolagLuxurysales

Source:PaulZimnisky,DeBeers,UBSestimates

Figure5:RoughDiamondsupplybyproducer(US$)-Figure6:Globalroughdiamondsupply(mcts)-mine

ConsolidatedsupplydominatedbyDeBeers&AlrosasupplyissettomoderateduetotheexhaustionofArgyle

DeBeers

Stornoway38%

Diamonds

1%

Petra

Diamonds

5%

RioTinto

5%

Alrosa

29%DeBeers■AlrosaOtherPetraDiamondsAngola■Zimbabwe■RioTinto

Source:PaulZimnisky,DeBeers,UBSestimatesSource:PaulZimnisky,DeBeers,UBSestimates

Figure7:Diamondjewellerysalesbysegment-self-Figure8:Roughandpolisheddiamondprices-Rough

purchases&lovegiftsvulnerabletosyntheticpenetrationpricesstabilised&polishedremainsunderpressure

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Roughdiamondprice(PolishedP)(LHS)

Polishedpriceindex(Rapaport)(RHS)

Source:DeBeers,UBSestimatesSource:Bloomberg,UBSestimates

Positivevsnegativedrivers

Figure9:Diamondindustry-PositivevsNegativedrivers

PositiveTailwindsNegativeHeadwinds

SupplySupply

Consolidatedminesupply=supplydisciplineDeclineinminesupplymainlylowquality(Argyle)

Geologicallyrarecommodity-nomajornewdiscoveriesGrowthinsynthetics

Flat/decliningminesupplymedium-termPotentialgrowthinsecondarysupply

DemandDemand

LateCycle-Exposuretogrowingmiddleclassincomein

Decliningmarriagerates

China/lndia

Growthinself-purchasing&lovegiftsLackofgenericmarketing

IncreasingdiamondpenetrationtoChinesebridalsectorMid-streamcreditissuescreatingdemandvolatility

CompetitionfromotherLuxurygoods(inctech)

Source:UBSestimates

Diamondequityexposure

Alrosa-Sellrating,PTRUB90/sh-Linktoinitiationreport

Inourview,Alrosaisafundamentallysoundbusinesswithhighqualityassetsand

offersahealthydividendyieldthatiscoveredbyFCF.However,webelievethe

marketunderestimatesthenear-termrevenuepressuresAlrosawillfacedueto

weaksupplyanddemandfundamentalsintheroughdiamondmarketandwe

challengetheconsensuslong-termbullishthesisondiamondsdrivenbymine

depletionandastrongdemandoutlook.Diamondmarketfundamentals

deterioratedin2H18,but12mforwardconsensusEBITDAhasonlyjuststartedto

moderate(down〜5%frompeak).Consensusestimatesimplyflatrevenuein

2019;FY19diamondsales(〜38-39mcts)areexpectedtobeup0-2%y/yandspot

RUBFXrateisbroadlyin-linewithFY18;consensusthereforeimpliesonlymodest

downsidetorealiseddiamondpricesinFY19.Inourview,consensusisyettofully

reflectdownsideriskstorealiseddiamondpricingduetonegativemixeffects.

AngloAmerican-Sell,PTGBp1,800/sh-Linktonote

DeBeersis85%ownedandconsolidatedbyAAL,butaccountsfor〜15%of

2019EEBITDA,andcomplexaccountingandadditionalminoritiesmeanthat

diamondsaccountforasmallershareofattributablenetincomeandFCF.Rough

diamondprices(polishedpricesroughindex)rose〜1%y/yin2018,thoughDe

Beers'realisedpricesrose17%asitmaintainedsalesofhighgradestonesbut

stockpiledlowergradestones.In2019weexpectbroadlyflatbenchmarkrough

prices,butseeariskthatDeBeers'realisedpricescomeunderpressuredueto

negativemixeffectsaslowgradeinventoryissold.Weexpectlowerrealisedprices

andanegativeproductionmixeffectwithinDebswana(lessownmineproduction)

tooffsetamodesty/yliftinsalesvolumes(drivenbydestocking-production

downy/y),resultinginamodest(~5%)declineinDeBeers'EBITDAin2019E.

Thesismap:

Diamonds

PIVOTALQUESTIONSQ:Willtheglobaldiamondjewellerymarketgrowin-linewithGDP?

Diamondsarea'latecycle'commodity,sodemandshouldbenefitlonger-termfromthegrowing

middleclassinEMs(China&India)vsmanyoftheotherindustrialcommodities(steel&coal).

UBSevidenceLabstudieshighlightthatjewellerywillremainakeycategorywithinLuxuryGoods;

asaresult,weexpectpositivedemandgrowthmediumterm.However,inourview,growthin

diamondjewelleryislikelytocontinuetounderperformthebroaderLuxuryGoodssector,driven

bylowermarriagerates(albeitthisislikelytobepartlyoffsetbyanincreaseinself-purchases)

andalackofeffectivegenericmarketingofdiamondsasabrand.Wethinkthe$80mtargeted

spendongenericmarketingbytheDPA(0.1%ofglobalrevenue)istoosmalltohaveamaterial

impact.Inourview,diamondjewellerydemandmaynotgrow'in-linewithGDP'asmanybelieve.

Q:Willamaterialcontractionindiamondminesupplydrivehigherroughprices?

Minesupplyislikelytodeclineoverthenext3years,driveninparticularbytheexhaustionofthe

Argyleminein2021.Lookingbeyondthis,therearenomajordiamondprojectsindeveloped

markets,withkeysourcesofgrowthinZimbabweandAngola,wherevisibilityismorelimited;as

aresult,constrainedminesupplyisasupportivemedium-termdriverfordiamonds.Argyleaccounts

for11%of2018roughdiamondsupplybyvolume,butjust2%byvalue;whileweacknowledge

Argyle'sclosurewillimpactthelowerendoftheroughmarket,webelievethedisruptiveimpact

ontheglobaldiamondmarketinvaluetermswillbemodestandispotentiallyoverstated.

Q:Aresyntheticslikelytomateriallydisruptthediamondmarket?

UBSEvidenceLabsurveysindicatethatnaturaldiamondsarelikelytoremainthecorecomponent

ofthejewellerymarketandwedonotbelievegrowthinsyntheticswillreducetotaldemandfor

naturaldiamonds.However,inourview,themarketpotentiallyunderestimatesthenegative

impactsyntheticscouldhaveonnaturaldemandgrowth.Weestimatethat$1bn(cimctsbased

on2018pricing)growthinsyntheticdiamondswouldreducenaturaldemandgrowthby20bps

over5years,andinourbasecase($5bnby2023E)theCAGRfornaturalroughdiamonds

demand(1.8%)wouldbe30%lowerthangrowthinthebroaderjewellerymarket(2.5%).

UBSVIEWPricingbottoming-outbutfundamentalheadwindsexist.Inourview,thefundamentaloutlook

fordiamondsissolidandourbasecaseisthathigherpriceswillberequiredtobalancethe

marketmedium-term.Butwethinksupplyanddemandfundamentalsmaynotbeasattractiveas

manybelieve,withdemandgrowthexpectedtolagoverallluxuryspend,andwebelieve

syntheticdiamondspresentacrediblethreattonaturaldiamonddemandgrowth.Nearterm,we

donotseeanyclearpositivecatalysts:enddemandinUSA/Chinaislacklustre/decelerating;the

marketforlowerqualitystonesisoversupplied;andthemajorsbuiltinventoryin2H18(8mcts).

Thisinventoryislikelytore-enterthemarketif/whenroughdiamonddemandrecovers,capping

upsideinbenchmarkpricesandnegativelyimpactingpricerealisationsforAlrosaandDeBeers.

UBSEvidencelabLuxurysurveysof>1,000luxuryconsumersinChina&USA;detailedglobalmine

EVIDENCE

byminesupplymodelandrealizedpricingcurve;syntheticdiamondmodellingandscenario

analysistoestimatetheimpactofsyntheticdemandgrowthonnaturalroughdiamonddemand.

MajorJewellers'4Qsales(Tiffany,Signet,Richemont,ChowTaiFook,LukFook);Alrosa&DeBeers

SIGNPOSTS

sightsales/inventoryupdates;syntheticgrowth(updatedgrowthplansfromsyntheticcompanies).

Figure10:Diamonds-supply&demandFigure11:RoughDiamondprices-upsidevsdownside

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BalanceNaturalRoughdemand(RHS),NaturalRoughSupply(RHS)

Source:PaulZimnisky,DeBeers,UBSestimatesSource:Bloomberg,UBS

Diamonds101

Whatarediamonds?

Diamondsarearare,naturallyoccurringmineralandthehardestknownnatural

substance.Thehardnessofdiamondsisduetothestronglyconcentratednatureof

thecarbonchainsthatmakeupadiamond'sstructure.

Whataretheyusedfor?

Thepriceanduseofadiamonddependsonitsquality.Highqualitydiamondsare

typicallyreferredtoasgemqualityandareusedinjewellery.Lowqualitydiamonds

arecommonlyreferredtoasindustrialgradeandareusedinindustrial

applications,primarilyincuttingandpolishingtools.

Howaretheyproduced?

Geology:DiamondsarefoundinatypeofanigneousrockcalledKimberlite.

Kimberlitewasformedbyvolcanicactivitywhichtookplaceduringtheformation

oftheEarth*scrust.Diamondsareformedwhencarbonisputunderextreme

conditionsofhighpressureandhightemperature,whicharefoundatdepthsof

125-200kilometresinsidetheEarth'scrustintheuppermantle.Thetemperature

atsuchgreatdepthsrangesfrom900℃to1,300℃.Thenaturalprocessof

diamondformationmaytakebillionsofyears.

Exploration:Diamondsoccurintwotypesofdeposits-primaryandsecondary.

Primarydepositstendtohavehigheraveragegrades,whereassecondarydeposits,

Alluvials,haveloweraveragegradesbutmuchlargeraveragestonesizescompared

withprimarydeposits.Theaveragegradeofminescanvaryfrom0.03toaboveFigure12:Explorationchances

3.0caratspertonne.Butforadeposittobeeconomic,thequalityanddistribution

Kimberlite

ofthediamondsisasimportantastheaveragegrades.Statisticallythereisless

thana1%chancethatadiscoveredkimberlitepipewillbecomeadiamondmine.

Exploringforthesepipesisdifficultduetotherelativelysmallsurfacefootprintof

thekimberlitepipes.Unlikeotherminerals,drillingisnotaneffectiveexploration

tooluntilafterapipehasbeenfound.Theinventionofelectromagneticsurvey

techniquesinthe20thcenturyallowedgeologiststopinpointkimberlitepipeswithDiamondiferous

greaterease.Onceakimberlitepipehasbeenfounditmustthenbedrilledand

bulk-sampled,aprocessthatinvolvesremovinganyoverburdenandthensampling■Economic

alargeparcelofthekimberlitematerial.NotallkimberlitescontaindiamondsandSource:PaulZimnisky,UBSestimates

notalldiamondscontainingkimberlitesareeconomic.Anotherpotentialproblem

isthatthetoplayerofthepipemayhavebeenenrichedduetoerosionand

thereforemaynotaccuratelyrepresentthegradeoftherestofthepipe.

Primarydepositsarethosewhichoccurindiamondiferouspipes,i.e.pipesof

mineral-richvolcanickimberliterockcontainingdiamonds.Thesedepositswere

carriedtothesurfaceinmoltenrock,alsoknownasmagma.Whilstsomeofthe

materialiserupted,muchofthemagmacoolsinsituaskimberlite,usuallyinthe

formoftaperedpipeextendingverticallybackdownintothecrust.

Asthepipesarepresentatsurface,theyarealmostalwaysminedusing

conventionalopenpitmethods,exceptforsomeCanadianpipesthatarebeneath

bodiesofwater.Oncethepitreachesanunmineabledepth,thenatransitionto

undergroundmethodsoccurs,typicallythroughlongholestopingorblockcaving.

Asundergroundminingismorecapitalintensivethanopenpitminingandmore

challenging,notallkimberlitepipesaredeemedeconomicallyviabletobecome

undergroundoperations.

Figure13:UdachnykimberlitemineFigure14:Typicalkimberliteminingmethods

Source:AlrosaSource:UBS

Secondary(Alluvial/Placer)depositswereformedasaresultoferosionof

diamondbearingkimberlitepipes,which,overaperiodoftime,havebeen

transportedawayfromtheiroriginalsource,normallybyfluvialerosion.Alluvial/

Placerdepositsaretypicallydiamondcontaininggravels.Thedepositsaren,t

particularlythick,buttheycancoverlargeswathesalongsideriversystems.Mining

placerdepositsisgenerallylowercostthanprimaryminingasonceanyoverburden

isremovedthediamondcontaininggravelcansimplybedugupandprocessed.

Processingtoroughdiamonds:Minedmaterialissubjectedtocrushingand

gravityseparationbeforex-raymachinesareusedtoseparatetheroughdiamonds

fromtheore.Theroughuncutdiamondsarethensortedbyhand.Diamondsthat

aredeterminedtobeofgemqualityaregradedaccordingtothe4C*s-colour,

clarity,caratandcut.Diamondsthatarenotofgemqualityduetothesizeor

colourareclassedasbortandusedinindustrialapplicationssuchasanabrasivein

cuttingtools.

Cuttingandpolishing:Thediamondindustryhasavitalbutconcentrated

midstream.Diamondproducersrelyonmidstreamprocesserstobuytheirrough

diamonds.Theythenprocessthestonesbycuttingandpolishing,andtheysellthe

processedstoneswholesaletoretailers.Midstreambarrierstoentryarelow,

marginsarethin,andtheindustryisreliantondebtfinancingfromspecialistbanks

tobuyroughstonesfromproducers.Asthetopproducerscontrol〜70%ofthe

roughsupply,theprocessorshavelittlebargainingpower;asaresult,midstream

businessesarelow-margin,makingthemacutelysensitivetochangesinfinancing

costsandpricevolatility.

Demand:growthinlinewithGDP?

Diamonddemand(expressedinUSS,notcarats)isoverwhelmingly(99%)drivenFigure15:Diamondsvaluechain

bydemandfordiamondjewellery;thiscontrastswiththeother'precious,

commodities,suchasgold,silverandPGMs,whichhavesignificantindustrial

applicationsand/orinvestment-drivendemand.

Diamondvaluechain:

Theglobaljewellerymarketwas〜$260bnin2018;diamondsaccountfor〜35%of

thetotaljewellerymarketandwereworth〜$80bnin2018.Inrecentyears,

As

JCp

diamonds*shareofthetotaljewellerymarkethasremainedfairlystableat〜35%®2u

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