The DTC: Pushing Prices or Pushing Carats?
July 28, 05I was never good at English literature but wasn’t it William Shakespeare who uttered the immortal words: “to stock or not to stock, that’s the question”? De Beers diamond sales in the first half of 2005 came to $3.22 billion, which was 7% beyond the sales of first half 2004 of $2.98 billion. But the increase of sales didn’t provide much joy to Chairman Nicky Oppenheimer or managing director Gary Ralfe. In a press conference they both stressed deep disappointment with the financial results of the first half of the year.
The “Diamond Account”, which is the profit line on the diamond operations, went down from $657 million in the first half (H1) of 2004 to $644 million in H1 2005 – and that is in spite of some 12% higher average per carat sales prices and a 7% growth in sales in money terms. The “diamond account margin” – which is the ratio of diamond profits to diamond sales – slightly declined from 20% in H1 2004 to 18% in H1 2005. None of this was unpredictable and what I found puzzling is why De Beers' management stressed its great disappointment.
To a large extent, the results should have been predictable given the source of the diamond sales: in the first half of last year, the DTC was still drawing significantly from old inventory. The last remnants of the historic stockpile which stood at some $5 billion (book-value) at the beginning of 1999, was sold in H1 2004. Since then new stocks are being accumulated again – but at different values. Thus the De Beers operating cash flow fell to $158 million in H1 2005, down from $971 million in H1 last year, as the latter figure including diamond stocks draw-downs of some $500 million.
Seasoned diamantaires will attest that even in periods in which they may not have made money on their business, they made money on the stocks. Looking at the price increases of the past few years, nobody who was sitting on stocks should cry. The company reported price increases of an average of 6% in 2005 so far, which comes on top of an average increase of 14% in 2004 over 2003 (or compounded 17% in 2004 itself).
I think that the “real disappointment” of the company comes from the fact that De Beers has completed its transition period, got rid of all ancient stocks (which are now carried by the industry, mostly at the kind courtesy of the diamond banks), and is now operating like any other company. Gary Ralfe actually remarked that "the results might indicate that we are coming down into what one might call steady state of performance now that we have achieved the great goals of the past few years of debt reduction, of managing working capital downwards, of realizing the great stockpile that we had of more than $5 billion when we started our transformation in the year ‘99/2000.” That’s exactly where De Beers finds itself today.
But there seems to be a renewed appetite for building up new stocks. In H1 2005 diamond mining production was 23.7 million carats, an increase of 23% over the same period in 2004. As a result of the increased production, stock levels have risen by about $400 million compared with June 2004.
Believe me – this is confusing. I suggest forgetting about that scary production increase of 23% -- no, there is no deluge forthcoming. De Beers total mining output in 2005 will be approximately 50.5 million carats, which is about 7%-8% above the 47.0 million carat level of
So, yes, De Beers is increasing its carat intake – but at the same time it is selling fewer and fewer carats. In 2004, the DTC sold substantially LESS carats than in 2003. The DTC now confirmed that “the total number of carats sold in the first six months were slightly, but not substantially, down on the first six months of last year.” Selling less and less carats, at the same time increasing mining output, and again starting to stockpile…..what does this mean to the diamond business?
One analyst (Des Kilalea) actually wondered aloud and asked De Beers management that “given the [mining] production increase and two price increases, I'm wondering if what we're seeing is a subtle shift in strategy such that you've decided to move prices rather than carats sold, and hence you're kind of deliberately building up something like a stockpile?”
DTC chief (and De Beers managing director designate)
The answer is “no”. And that is puzzling as well. The DTC implied that the second half sales would be similar to the first half, i.e. $3.2 billion. Thus we are looking at a full year figure of somewhere around $6.5 billion. This can be concluded from a remark by Gareth on seasonality. Said
After saying that,
Now if the second half is like the first half, but we started off with a price increase in July, then, again, to reach the same money levels LESS carats will be sold.
Surely, all this talk about DTC sales and stock levels should be tied to the demand for diamond jewelry. My research has indicated that sales are rather flat – and that the consumer basically still pays the same price for diamonds as he paid a few years ago. Any price increase in polished has been achieved on a wholesale level, within the diamond value chain, and is then cancelled out by reduced profit margins on the retail level.
“With the macroeconomic indicators that we see in the United States, and with the amount of investment that is going into downstream marketing for diamond jewelry, we are looking to a 6% increase in our retail markets measured in local currency, and of course we remind you that as a counterpoise to the United States, we have growing and important new markets in Greater China, in India, in the Gulf and we also see a blossoming out of the market in Japan,” says Ralfe.
Assuming that the strength of the new markets will edge the final 2005 diamond jewelry growth figure slightly above 6%, we should not ignore the fact that in the H1 the DTC sales were 7% higher than in the same period last year – but that prices were some 12% higher than they were in the first half of 2004.
So the question whether the DTC is pushing “prices” rather than “carats” is not at all out of place – and the answers aren’t that simple. [Incidentally, in the H2 of this year, the DTC is accommodating some 11 new Sightholders in addition to all the existing ones. If the DTC sells the same value in H2 as in H1, how are they going to accommodate these newcomers? Will all receive slightly less in value and considerably less in carats? Price rises are of course not uniform. But I have talked to Sightholders who received in H1 2005 about the same amount of goods and similar goods as in H1 2004, but they received some 25% fewer carats! There is no way in the world in which such situation represents a “growing business.”
The De Beers management, while down on their own results, are optimistic about the market. I admire them for that – as leaders of the market they should never give public hints or show hesitations about the future. They know how to instill confidence – and that’s good. But if they expect the diamond jewelry market to grow by some 6%-7% worldwide in 2005, and given the price increases we have seen already, and assuming that
Maybe De Beers does want to create a new stockpile – as it has learned the hard way that it is harder to make money when you have only a working stock. I clearly note
Have a nice weekend.