De Beers Sales Growth Mostly Inflationary; Carat Production Down

Given the rather buoyant diamond market, DTC sales for the first half of 2004 are somewhat disappointing, rising by just $63 million or 2.2% from $2.920 billion in the first half of 2003 to $2.983 billion. De Beers’ Managing Director Gary Ralfe made it a point that the average sales price this year was 14% higher than that of last year, so, in real terms, sales actually declined. One might counter that the producer sold fewer carats at higher prices and that should only be viewed as positive, which gets us back to the more philosophical question of what is more important: the volume or the money. I have a tendency to take the downstream player’s perspective and look at volume as the industry is manufacturing carat volume and not money. All downstream players make money solely on the added value, and the greater the volume of diamonds at the right price, the higher the value added and the profits. Higher per carat values are never a convincing consolation to a diamantaire which has to lay off workers because he cannot get sufficient volumes.

A producer, in contrast, looks mostly at the price. The higher the selling price, the greater the profit. What especially struck me with the release of the first half results, was De Beers being very candid about its rather unexpected carat production problems. This candidness doesn’t increase the comfort level of the downstream industry where there prevails – rightly or wrongly – a perception that De Beers may not have enough diamonds to support the Supplier of Choice marketing programs of its clients. 

De Beers notes that it is encountering some production problems in Botswana where the output levels are 20% below budget and 12% below the output of the first half in 2003. In contrast, Nambia’s De Beers output was up 33% over last year’s first half and some 16% in South Africa, mainly due to the strong performance of Venetia.  For the first half-year of 2004 overall ouput was 18% behind budget and 2.6% below last year’s first half. For the year, De Beers believes that it may be able to increase overall production by 5% by year-end (compared with the 7% target). A number of marginal South African mines are actually producing at a loss, due to the strong South African rand. That situation has now further deteriorated and Gary Ralfe stresses that social considerations – the importance of providing work for its workforce – have prevented so far the closing of mines.

Looking at hard numbers, total carat production in the first half of this year was 19.3 million carats against a planned budget of 22.8 million carats. Budgets are essentially targets – figures that should be attainable unless unexpected events occur. This is what happened in Botswana, where the unexpected decline was attributed mostly to mechanical equipment failures at Jwaneng and Orapa.

In the press conference, Gary Ralfe was positive about the market. He noted that polished prices had also increased by some 10% this year; he was particularly happy about Japan, which, for the first time since the bubble burst in Asia, saw an increase in diamond consumption. De Beers reports good growth in diamond jewelry retail sales in the first half, although last year's interims were impacted by the Iraq war and SARS. 

Global diamond jewelry sales are estimated to have risen between 7% and 8% in dollar terms during this period, but it must indeed be remembered that the first half of last year wasn’t great. The figures certainly give reason to believe that retail sales for the full year will be comfortably higher than in 2003, especially because of the some 10% higher polished prices achieved already. Here, too, some caution: if the polished market increased by 7%-8%, this is less than the inflationary price growth. Thus De Beers sold fewer carats rough, and the retailers sold fewer carats in polished.

As DTC Chief Gareth Penny is fond of comparing the diamond performance with other luxury products, it is interesting to look at the performance of LVMH. This company has an annual turnover of 12 billion euros (and is five times as large as Gucci), so its performance may be indicative. We only have the figures for the first quarter of 2004. They show an increase of 10% to reach 2.8 billion euros. However, if I want to compare apples with apples and convert the LVMH to dollar figures, it registered an increase from $2.75 billion in last year’s first quarter to $3.41 billion this year. That represents a growth of 24% -- and that is only for the first quarter, not the half year (and the second quarter may well be less buoyant, we don’t know yet). The United States represents 25% of the LVMH market; about a third of its sales are in Japan and Asia. But let’s go back to diamonds.

According to De Beers, polished stocks have declined in the cutting centers, and prices have risen for most categories. Cutting center debt remains at historically high levels, but De Beers believes that this has not increased since the start of the year and will hopefully begin to fall in the next half year. Ralfe continued to caution against the too high market price of rough (too high in relation to polished) – and, indeed, the DTC selling prices are below those of the other major producers.

The company reported headline earnings for the six months ending June 30 of $424 million. In the diamond industry, we look at the profit margins on sales. This shows that the net diamond account margin increased from 15.4% to 18.0%, which partly reflects the impact of the price increases and the reduction of $400 million in diamond stocks. Diamond stocks are reported together with “other assets” and it is hard to get an accurate reading of these. The book values of these are now $1.357 billion. We think that actual diamond stocks (without other assets) are more in the range of $850-$900 million, about the equivalent to about one and a half sight. We hope that it is more.

De Beers’ management has given the market a very candid and straight report on its operations, its expectations and its market forecast. For this they deserve to be complimented – as a private company they are under no obligation to give as much as they have done. From a downstream perspective some of the news could be better – but that’s already a matter of interpretation. These are certainly not easy days – in spite of the positive market sentiments.