Equity Analysis /
Russia

Alrosa: Buyers unperturbed by spiking diamond prices

  • The next great supply shortage is diamonds

  • There’s genuine demand on both the rough and polished level

  • Looking at positive trends both on the supply and the demand side, high chance that rough diamond prices can rally in H2

Boris Krasnozhenov
Boris Krasnozhenov

Head of Research (Managing Director)

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Yulia Tolstykh
Yulia Tolstykh

Analyst, Metals & Mining

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Alfa
12 July 2021
Published byAlfa

The next great supply shortage is diamonds: Just over a year ago diamond jewelry consumers were sat at home for two months leading to a 35% decrease in April-June 2020 sales. But as lockdown conditions eased consumers rushed to buy diamonds, thus leading to flat y/y 2020 jewelry sales. In 2021, the stimulus measures and the vaccine rollout has boosted economic optimism and demand for diamond jewelry has grown by 15-30% vs 2019 in 5M21 across the key markets – to record levels. Now, the polishers, wholesalers, and even luxury diamond jewelry producers, who form the backbone of the global diamond sector, are competing for stones. The major rough diamond producers, including ALROSA and De Beers, have limited supply to bring to the market. Rough diamond supply is down c.20% by volume and c.10% by value on 2019 prices. The structural shortage of rough diamonds is also driven by several mine closures. The largest closure was Argyle in Western Australia, which accounted for roughly 10% of global production, though we should admit its mix was skewed to smaller sized stones as in value terms Argyle is just 2.5-3% of the global supply. In addition, the major producers managed to sell down nearly all stocks in 1Q21 that they had built up last year. By 2Q21 ALROSA had 12.5mn ct of diamond inventories with a minimum stockpile required of 8-8.5mn ct for normalised operations. We are aware of market speculation that the Russian government is also looking to capitalise on the strength of demand and tight supplies, as it mulls selling more rough diamonds from the state stockpiles (Gokhran). However, it is unlikely to bring supply relief to the market as ALROSA is likely to bid for the Gokhran volumes to replenish its own inventories. Online diamond jewelry sales also add uncertainty to the supply-demand equation in the industry. According to the Bain consultancy, in 2021, the sales through online grew roughly 2x at almost all retailers who publicly disclose their results. If we extrapolate that to the wider market, diamond jewelry sales are close to $80 bn (mid-cycle number), and the growth from 10% to 20% in the online sales share means $8bn of sales (or $2 bn of polished diamond equivalent). Online sales enable the reduction of inventories for retailers and lead to a structural decrease in jewelry sales to the jewelry inventory ratio. It is certainly good for the rough diamond industry as it makes re- and de-stocking cycles shorter, thus reducing price volatility. The retailers will have to stock up before the holiday season of 2021 in August, in our view, strengthening demand for rough diamonds moving down the value chain. That is creating a sense of scarcity at every stage of the pipeline.

There’s genuine demand on both the rough and polished level: Ultimately, both polished and rough diamond demand is driven by consumers buying diamond jewelry and over sentiment in the luxury segment. The major retailers in the US and China are buying aggressively to keep up with strong diamond jewelry sales. The statistics we have collected on the market provide solid grounds for a positive trend on the demand side in the diamond sector. Nearly 40% of overall consumer spending in developed economies comes from the top tenth of earners. The wealthiest 10% of Americans added more than $8 tn to their net worth in 2020. According to Harvard University research, high-income consumer spending is now 11% higher than the pre-pandemic level, and consumer spending in the US could grow at the fastest pace since 1946. US spending across all categories including jewelry (+46% q/q in 2Q21 vs 2019). The overall jewelry spending in the US is up by over 30% in 5M21 vs 2019 levels - an all-time record. We note that Signet Jewelers upgraded their sales outlook for 2Q21 to +76-82% y/y (up c. 25% vs 2019). Luxury spending in mainland China continues to be strong in 2Q21, showing no sign of deceleration, helped by Hainan, where duty-free sales were up +980% y/y in April (after being up 215% in 1Q21). The positive trends are recorded across the broader Asia region as April luxury spending in South Korea was up 70% vs. 2019. The polished diamond prices, which have long weighed on the industry, are finally rising. Rapnet polished prices for a 1 ct diamond delivered remarkable growth of 20% y/y in June 2021. It leaves thick margins for the mid-stream, including polishers and wholesalers, and secures solid demand for rough diamonds moving into the second half of this year.

What’s the diamond price upside? Looking at positive trends both on the supply and the demand side in the diamond sectors, we see a high chance that rough diamond prices can rally in 2H21e. We apply a fairly straightforward logic and basic assumptions to derive our estimates. It takes about three months to cut, polish, and sell a diamond, so stones bought cheaply at the start of the year are now being sold for a sizable profit. That also means those buying at today’s prices are betting that polished stones will continue to appreciate in value. The polished diamonds as of June 2021 are up 7% vs. early 2019 levels. The rough diamond prices are up c.15% YTD though still 4-5% below early-2019, pre-crisis levels. ALROSA’s rough diamond price at the beginning of the year was around $126-128/ct. In June 2021, the price has gone up to $145-150/ct. If we go back to the first half of 2010s, when the market was in balance, we find rough diamond price levels of $170-175/ct. History shows that the rough diamond prices in nominal terms were hovering around $170-175/ct before 2013. We estimate that in today’s US dollar prices, applying official inflation stats, the rough diamond price level could be close to $210/ct. The upcoming sights in 2H21e will prove if the presented scenario is realistic. However, if more money chases fewer diamonds the price rally looks reasonable. Taking into account ALROSA’s solid dividend policy and strong balance sheet, it may trigger a solid re-rating in the name.