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Harry Winston (FRANCOIS MORI)
Harry Winston (FRANCOIS MORI)

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Diamond outlook still needs polish Add to ...

A few months ago, Robert Gannicott couldn't see a bottom for the world's rough diamond markets.

The chief executive officer of Harry Winston Diamond Corp. watched as prices fell by as much as 70 per cent for the raw material, which after polishing and cutting is set into jewellery.

"We began this quarter with a rough diamond market that could see no bottom and retail sales effectively stalled," said Mr. Gannicott as the company reported a quarterly loss last week. "We ended the quarter with consistent improvement in rough diamond prices and the return of customers to our retail stores. This improvement has continued through May."

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Unlike other commodities, there is no world benchmark used to assign values to diamonds. There are too many variables - size, clarity, colour are among the most important factors used to assign value.

Harry Winston typically offers its rough diamonds for sale twice per quarter, and sold $57-million (U.S.) worth in the first quarter, compared to $81.4-million in the same quarter a year ago. BMO Nesbitt Burns estimated the company realized an average diamond price of $58 a carat in the quarter.

And while industry analysts said average prices for rough diamonds have increased about 33 per cent from recent lows as producers cut operations, investors should be skeptical of signs the industry is recovering, said Des Kilalea, a London-based diamond industry analyst for RBC Dominion Securities.

What does Harry Winston do?

The company operates in two divisions - it's part miner, part retailer. It pulls rough diamonds from the Diavik mine in the Northwest Territories, in which it has a 40 per cent stake. Workers extracted 3.9-million carats from the site in fiscal 2009.

The firm also operates Harry Winston Inc., which is a fine jewellery and watch retailer with 18 salons across the world. While the company earned $70-million last year, its most recent quarter reflected the decreased demand for raw diamonds as it posted a $45-million loss.

What has its stock done?

Since scraping against a low of $2.27 in March on the Toronto Stock Exchange, the company's shares have gained about 211 per cent as investors bet rising consumer confidence in the United States - the world's most important diamond market - could give a boost to retailers such as Tiffany's Co. and Harry Winston.

"Among the producers, Harry Winston is probably as well positioned as any to withstand the drop in demand and come out the other side," said Edward Sterck, a London-based analyst for BMO Nesbitt Burns.

He said Harry Winston's March decision to sell a stake in the Diavik mine - as well as a stake in the company itself - to Kinross Gold Corp. for $150-million would help it withstand the downturn, giving it the buffer it needs to avoid selling into depressed markets.

Nine analysts follow Harry Winston, with four "buy" ratings, four "hold" ratings and one "sell." Their average price target is $8.18 a share.

Downside risk

The bounce in rough diamond prices has come largely from the actions of two major players - the Russian government - which has stockpiled much of the country's production - and De Beers SA - which has substantially cut back its operations.

"These big producers behaved rationally and responsibly," said Mr. Kilalea. "They helped the market find a bottom, but we won't get anything moving off the bottom until that retail market turns more rosy."

Before that can happen, he said, Americans need to stop losing their jobs and consumers must be confident enough to spend thousands of dollars on what is purely a luxury item. In the meantime, he doesn't expect cash-strapped miners to increase production (or earnings) until the market shows signs of recovery.

"Having too many diamonds on the market isn't in anyone's best interest," he said, adding Harry Winston has plans to halt its mine for six weeks later this year.

Mr. Sterck does see an upside for Harry Winston's shares - for long-term investors willing to wait for their gains.

"We're not out of the woods at the moment," he said. "It's going to be a tough year, but in the medium to long-term I'm forecasting a recovery in prices, which should help them substantially."

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