Gemfields Group Limited: A Gem of a Company
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If you thought that Georgia and Papua New Guinea were obscure, I'd buckle up for this one. A former private equity spin-off, Gemfields Group (Gemfields) is the world's largest miner of colored gemstones. Headquartered in Guernsey, a small British island off the coast of England, the company dominates the industry in which it operates, has various competitive advantages, and on a quantitative basis is shockingly cheap. That said, Gemfields' primary operations are in Mozambique and Zambia- not exactly countries known for political stability. Still, I believe that a combination of excellent management, the national importance of its assets, and, of course, price, makes Gemfields an attractive opportunity.
Led by Brian Gilbertson, Gemfields Group was taken public as Pallinghurst Group, a private equity firm focused on metals and natural resources. The modern iteration of the company began at the start of its fiscal year 2018 when Brian passed leadership of the business to his son, Sean, who is still CEO today. With this leadership change came a renewed focus on its core assets and, of course, a name change. Today, the company owns and operates the world's largest emerald mine and ruby mine. In addition, it owns the iconic House of Faberge, as well as licenses and ownership stakes in some smaller mines.
Business at a (Very) High Level
A great mental model to apply when trying to understand the colored gemstone industry is that of another commodity- oil. At a high level, the oil industry has three parts: upstream or exploration and production, midstream or the logistics part of the industry, and downstream or refining product and bringing it to market. This structure is very similar to metals and other natural resources, such as colored gemstones. As a miner, Gemfields is primarily upstream-focused, though its ownership of Faberge gives it a downstream presence as well. In plain English: the company searches for, mines, and subsequently sells colored gemstones.
To get a grip on the company it is important to first understand each of its assets. Gemfields' three main assets are its emerald mine in Zambia, its ruby mine in Mozambique, and its ownership of Faberge. The company also owns other, smaller assets, though these can be viewed largely as a call option.
Located in Zambia, Kagem is the world's largest emerald mine, controlling about 25% of global supply. Gemfields owns 75% of the license for this mine, with the other 25% being owned by the Zambian government. In 2022 the mine generated $74M of EBITDA on $149M of revenue, of which Gemfields gets 75%. Though Zambia is known to have the lowest grade emeralds of any of the world's major producing regions, Gemfields is able to sell their gems for five times the region's average. It is also worth noting that this mine has brought relatively little security risk with it.
Montepuez Ruby Mine (MRM) is located in Mozambique. In 2022 the mine generated $83.5M in EBITDA on $167M of revenue. The mine accounts for about 50% of the world supply, with Gemfields splitting the license 75-25 with the government of Mozambique. Sound familiar? Still, there are a couple of key differences between the two mines. First the positive: Mozambique has the highest grade rubies of any region in the world. Now the negative: Mozambique is experiencing political unrest, bringing with it security concerns around the mine. To date, MRM has had no negative incidents related to this political unrest.
Though it is still burning cash, and is a small part of the company, Faberge is a particularly interesting piece of the Gemfields puzzle. Founded more than 180 years ago (yes, you read that right), Faberge is a storied jeweler. With a focus on colored gemstones, the company is typically known for a rather idiosyncratic product- its eggs (yes, you read that right again). Often associated with European royals of the 1800s and early 1900s, these eggs engrained Faberge's place as a high-luxury jeweler. After being nascent for decades, the brand was bought by Gemfields in 2009. The company relaunched the brand, and today sees it as a driver of colored gemstone demand. As previously mentioned, the business is still losing money, though Gemfields management expects this to change in the next year or so. Long term, the vision of the company is to become the "De Beers of colo[u]red gemstones," by creating a positive feedback loop between Faberge and the mines. Gemfields does not directly sell its gems to Faberge. Like any other customer, gemstones must be acquired through auctions.
Sedibelo: Gemfields owns 6.54(?)% of the Sedibelo platinum mine in South Africa. The company is currently trying to monetize this stake
Web Gemstone Mining (WGM): Gemfields owns 75% of the license of WGM to mine emeralds in Ethiopia. This was previously an active asset and management hopes to restart operations when they deem it to be safe.
Other assets: Gemfields owns five other smaller mining licenses. These licenses are mostly centered around colored gemstone mining, though none are operating today. You guessed it! The company splits these licenses 75-25 with local governments.
Colored Gemstone Market
An important first note would be that all of the numbers are approximations. The reality is that this is the case in many businesses (despite what your favorite CEO said on the last earnings call), but this is particularly the case for the colored gemstone market. The industry is extremely fragmented, with much of the world's supply coming from illegal mining- think 2006 hit movie Blood Diamond. This makes responsibly sourced gemstones, such as the ones produced by Gemfields, a true rarity. This is a major difference in comparison to the diamond industry. For reference, Gemfields controls about 50% of the market of rubies, 25% of emeralds, and has no competitors of note. In contrast, the diamond market's top five players make up about 96% of the market, with three players having at least 25% market share. This is a massive difference that is not appreciated by the market, though we'll get to this later.
Gemfields has a set of proprietary tools and procedures that it uses to track the gemstones from mining to auction. This is one of Gemfields' true differentiators. For those of you that have not seen Blood Diamond, illegal mining is a serious human rights issue. This makes responsibly sourced gemstones more valuable. Gemfields puts rigorous effort into making sure that its gemstones can be tracked from mining to auction. This is one half of the magic that makes the company the industry's preferred seller- leading to premium sale prices at auction.
Now to the other half of that preferred seller magic. Similar to the tracking system, Gemfields has a proprietary grading system for the gemstone it mines. This system is used to determine the quality of the stones, which then plays into their auction price. This is another major advantage that the company has over any potential, though unlikely, market entrants, as well as over the diamond mining industry as a whole.
One of the biggest surprises for me in studying the colored gemstone industry was learning that emeralds and rubies both have a higher carat density than clear diamonds (though less than colored diamonds which are in a league of their own). This makes colored gemstones more levered to the very wealthy, which in turn has a couple of benefits. The first is a higher selling price, I don't think I need to explain why that is a good thing for a colored gemstone miner. The second is the resiliency of the price of these gemstones- even through the toughest of recessions. The best evidence of this is to look at the Great Financial Crisis. Despite a major global recession, colored gemstone prices continued to rise.
I am sure there are some that by now are thinking, "That's all great but how does it translate into results," to which I would answer with a definitive "Well!" MRM and Kagem do 50% and 49% EBITDA margins respectively. This is comparable to the gross margin (!!!) of even the best diamond miners. Simply put, it's a better business.
After being mined, gemstones are transported for auction. These auctions are set up and hosted by Gemfields. The company has done exceptionally well in making auctions easily accessible from anywhere. All auctions are available online, with the option for in-person viewing at select venues. There are two live ruby auctions a year, which are held in person in Bangkok, Thailand. Emeralds are split between two locations depending on quality. Commercial quality emeralds are auctioned in Jaipur, India, while higher-quality gemstones are routed to Bangkok. The company aims to hold two higher-quality auctions and two commercial-quality auctions per year.
Many companies have trouble and eventually fail when they enter foreign markets- particularly those that are more off the beaten path. This occurs far too often because the company does not understand the local cultures and economies. This is not the case for Gemfields. Actually, it is the opposite. Gemfields is a truly Africa first Company. As can be seen by the licensing structure, Gemfields (very literally) considers the local government its partner. In addition, the company is one of the largest taxpayers in both Mozambique and Zambia and the out and out largest in the provinces it operates in. This aligns the incentives of the government with that of the company. Gemfields takes this even further. Rather than bringing in talent from Europe, nearly all hiring is done locally. The company will often go as far as to build towns and infrastructure in these local economies, committing 1% of all of its mining revenues to this. Again, this is a truly Africa first company.
In analyzing Gemfields' management team, the first item of note is the strong representation of African citizens. This is essential in establishing common ground and cultural understandings in the countries in which the company operates. This list includes CEO Sean Gilbertson, largest shareholder (through his role as CEO of Assore) and board member Peter Sacco, as well as half of the board in total.
The key figure to gauge at Gemfields is the CEO (shocker, right?). Sean Gilbertson was placed as CEO by his father, Brian Gilbertson, who had taken the company public as Chairman. While many may say this wreaks of nepotism, it is important to the company as it ensures focus on the long-term vision to build the "De Beers of colo[u]red gemstones." This will become a differentiator for the business as Feberge turns profitable and scales over time. As mentioned before, this also creates a positive feedback loop between the industry's supply and demand.
It is also worth noting management's pay package. C-suite pay is largely tied to performance. Specifically, it is tied to a combination of earnings per share growth and total shareholder return. This incentivizes management to think about the bottom line, and to do it on a per share basis. In addition, this stops the hoarding of cash. Who doesn't love a shareholder aligned management team?
Despite my continuous hope that one of these quarters management will shift their focus to buybacks, they are insistent on returning the cash as a dividend. This still should still bring with it a nice return due to the large amount of cash these mines generate. Management is guiding for slightly lower figures than last year, though based on this year’s first auction, flat seems to be a conservative bet. Management says that despite prices coming down from the highs, they are settling around current levels. For reference, the first auction of 2023 had the third-highest price paid per carat ever. Assuming these levels are approximately the average for the year, the company should generate stronger cash flow numbers in the first half of 2023 compared to 2022, and the inverse in the back half of the year. Based on today’s closing price, the company would return 21% of its market cap through dividends this year alone. As mentioned earlier, gemstone prices increase over time, though I will be conservative in assuming the company experiences zero growth. This would return all of your cash to you in five years, with a few extra percentage points for good measure. It’s worth noting that both MGM and Kagem have very long expected lifespans, meaning depletion is not a concern.
Now to the part that could generate the real outsized returns. This comes from the company’s various embedded call options. The first being the six other licenses. These six are constituted by five exploration licenses, and the WGM license, which will be a producing mine once the area is deemed safe to operate in again. Should any of these licenses turn into producing mines the gains should be substantial, though the exact impact is impossible to gauge. Second is Faberge. Today, the business is money-losing, though this should inflect sooner than later. If and when Faberge turns positive the business has the potential to turn into a massive cash generator. Just look at any publicly traded luxury company. The third category of call option here is simply valuation. Normally I would never put valuation into this category, but I think it is, unfortunately, unlikely that the market will realize how much better of a business this is compared to diamond miners. I believe that Gemfields should trade at, at least, the same valuation as Anglo American (AA)- the company it is modeled after. Though AA is a larger, more diversified company, Gemfields is a far better one. For what it's worth, I say that makes valuation parity fair. Miners are usually valued based on their price-to-book value (P/B). Achieving price parity with AA would be exactly a triple from today’s P/B of 0.4.
Other Items of Note
Gemfields is dual listed on both the London Stock Exchange, as well as the Johannesburg Stock Exchange (did I mention that this is an Africa first company?)
Due to their combination of scarcity and leverage to the wealthy, colored gemstones prices tend to rise over time, even through a recession
Because gemstones are set to be auctioned at uncertain prices, gemstone inventory on the balance sheet is valued very conservatively
Risks and Rebuttals
Security is a real concern, especially at MRM. Though there have been no incidents in both Mozambique and Zambia, this is a risk that an investor needs to be comfortable with. That said, the company invests heavily in security and works with the local governments to proactively prevent any issues.
The creation of lab-made gemstones has been flagged as a concern by some industry commentators. I view this as being little threat to the natural colored gemstone market, if at all. This is largely due to its leverage to the wealthy. When spending tens, or even hundreds of thousands of dollars customers want the real thing (or so I've heard).
Again similar to the oil industry, mining intuitively has the potential to spawn safety concerns. While this is inherent to the business, Gemfields has an excellent safety record.
Though it does come with inherent risks, Gemfields offers a unique opportunity. In its current state, the company can potentially return its whole market cap in dividends within five years. In addition, the trifecta of call options creates the potential for some massive upside. Whether it be Faberge’s inflection, any of the licenses turning into operating mines, or simply the rerating that the company undoubtedly deserves, Gemfields offers a strong base rate of return plus the potential for truly massive returns.