Mountain Province Diamonds Look Cheap But Have Liquidity Issues

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Introduction

They say a diamond is forever and Mountain Province Diamonds (OTC:OTCPK:MPVDF) owns a 49% stake in the world’s fifth largest diamond mine – Gahcho Kué in Canada. The company has shown good results in the first quarter as the diamond industry recovers well from the effects of the COVID-19 lockdowns. Revenue during the period increased 56.1% year-over-year to C$84.7 million ($66.8 million), while net profit more than tripled to reach C$24.3 million ($19.2 million).

However, I believe that these good results come too late to save investors from the company as major liquidity problems loom on the horizon. Mountain Province Diamonds has $299.9 million in senior secured notes due Dec. 15 and it looks like a significant debt restructuring or stock dilution is inevitable. Let’s review.

Company overview

Mountain Province Diamonds owns Gahcho Kué in partnership with global diamond producer De Beers. The mine is located in the Northwest Territories and is the richest asset in De Beers’ portfolio with a reserve of 1.51 carats/tonne.

Gahcho Kué is currently the fifth largest diamond mine on the planet with an annual production of around 7 million carats. It has a lifespan of about 8 years.

Profile of Gahcho Kue

Mountain Province Diamonds

I consider this mine to be a Tier 1 mining asset located in one of the best mining jurisdictions in the world.

According to an updated March 2022 NI 43-101 Technical Report, the after-tax net present value (NPV) attributable to Mountain Province Diamonds is $759 million. Based on the mining plan, 2022 and 2023 should be the best two years for Gahcho Kué in terms of production and cash flow.

Gahcho Kue cash flow

Mountain Province Diamonds

Gahcho Kué currently has proven and probable reserves of 42.6 million carats, but I expect this number to increase in the future. The project hosts four major kimberlite bodies located within 2 km of each other and Mountain Province Diamonds has amassed over 107,000 hectares of claims and leases that surround the mine. In November 2021, a previously unknown extension of kimberlite was exposed in the northwest face of the Hearne open pit.

Exploration potential of Gahcho Kue

Mountain Province Diamonds

Turning our attention to the global diamond market, the numbers look compelling as strong demand and weak supply growth after the end of COVID-19 lockdowns have pushed prices to levels we haven’t seen. in the recent past.

World diamond production

Mountain Province Diamonds

Mountain Province Diamonds Average Carat Selling Price

Mountain Province Diamonds

The strength in the diamond market helped Mountain Province Diamonds post net profits of $19.2 million in the first quarter of 2022, with an average carat sales value of $132 per carat. Most of the company’s revenue comes from open market sales and I expect the next few quarters to be even better as there is a clear seasonality in the business. As you can see from the graph below, the first quarter is generally the company’s weakest quarter in terms of carats sold.

Carats of Mountain Province Diamonds Sold by Quarter

Mountain Province Diamonds

Still, I think it might be a bad time to invest in Mountain Province Diamonds, even if diamond prices remain high. You see, the company itself admits in its Q1 2022 financial report that it is facing liquidity issues because there are $299.9 million in senior secured notes maturing mid- December 2022 (page 8 here). The company will not be able to repay the notes with operating cash flow, which means that a restructuring of this debt could be on the horizon.

These notes are secured by a second lien on all present and future assets, property and businesses of Mountain Province Diamonds, which means that obtaining additional funds or renegotiating the notes is crucial. As the deadline approaches, I think it’s no surprise that the company’s share price hasn’t risen much since the start of 2021 despite much higher diamond prices. . Note that Mountain Province Diamonds’ primary listing is on the Toronto Stock Exchange.

Mountain Province Diamonds Stock Price

Mountain Province Diamonds

Even if the company manages to raise new financing, I think there will likely be significant stock dilution. For example, Mountain Province Diamonds entered into a credit facility on March 28, which included the issuance of 41 million common stock purchase warrants with an exercise price of $0.60975 per share. The company has 210,909,141 shares outstanding and its market capitalization stands at C$154 million ($121.4 million) at the time of writing.

Overall, I think Gahcho Kué is among the best diamond mines in the world and the diamond market looks strong right now. Mountain Province Diamonds looks cheap if you look at its profitability and the company is trading at a significant discount to net asset value attributable to its stake in the mine. However, it appears that significant stock dilution is occurring even if Mountain Province Diamonds manages to find a way to manage its senior secured notes. And if not, it looks like insolvency is a possibility.

Takeaway for investors

Liquidity issues can drag down even companies with attractive assets and I think Mountain Province Diamonds is a good example of this idea. Gahcho Kué is a very good mine with an excellent cash flow profile, but it cannot generate enough cash by December to enable Mountain Province Diamonds to repay its senior secured notes. The company must restructure its debts or find a way to refinance them. However, the last lender received a large number of warrants exercisable at only $0.60975 per share and this route is likely to result in significant stock dilution.

So how do you play this? Well, I consider shorting commodities stocks to be dangerous and it’s also very unclear how the debt situation will play out anyway. For now, I plan to put Mountain Province Diamonds on my watch list and may consider investing in the company’s stock once the senior secured note issuance is complete. You can expect me to be back in this business by the end of 2022.

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