Description

Lucama’s primary asset is the Karowe diamond mine in Botswana. Before I go into the investment thesis in more depth, let me start by saying I typically never touch natural resource companies, but I was drawn to Lucara as a traditional value investor. A few elements drew me to Lucara:

1. Depressed Canadian stock price, despite reporting in USD and earnings from dollar denominated diamond sales. Adjusting for the recent large recoveries (est. $75M) and proceeds from recent tenders the Company is worth $380M USD. 

2. Company is trading for less than 4x LTM EBITDA, despite a mine plan that goes to 2027. The Company generated 175M of EBITDA in 2014 and is on track for $125M of EBITDA in 2015 excluding sales and earnings from recent finds. On a forward basis, I think its probably less than 2x EBITDA for a long life asset.

3. The Company just completed a significant ($55M) investment in a new diamond recovery plant. Early results from plant upgrade are incredible with average stone recovery size up 35% to 33 carats in Q3. The Company announced the recovery of a 1,111 (2nd largest stone ever found), 813, 374, 348, 255 carat stones in the last week. At 40K per carat, that implies they found $115M of rocks in the last week (worth ~75M after 10% royalty and tax) relative to a $380M EV. I am not a mining expert, but if they have 12 more years to dig in this hole and they keep finding really large, really valuable rocks with their new machine we should do really well. Given we only have 1.5 quarters of data with the new machine in the more resource rich south lobe, it is impossible to know the true earnings power of the business. That said, forward EBITDA could be north $200M+ given fixed opex and significantly higher revenue from recovery of large stones.

4. Karowe is a special mine. They consistently produce really large stones and pricing has held up very well. While overall diamond sentiment couldnt be worse given soft Chinese demand, LUC plays in a portion of the market that has not been tagged with declining prices. Their stock has declined with other commodities and other diamond producers, but they really are selling a different "commodity" that has had a much different demand / pricing profile. Their realized prices are roughly flat this year. 

5. The Company provides data on all exceptional stone tenders and has a scatter plot of $/Carat realized on their website. It is clear from this data and the life of mine plan, that the resource consistently produces large stones and recent finds are not a fluke. Based on the data from multiple exceptional stone sales, they generally sell exceptional stones for $35K per carat with a range of $20K-$60K. The 1,100 carat is a once in a century find and could be worth much more, although its too soon to know as the stone has not been scanned in Amsterdam.

6. The Company has two other prospects and largely spent the required capital and exploration $$ to evaluate. The 367 and 371 pipes are free call options and could provide material upside if sampling proves economic. We should get initial results next quarter.

7. Management has a great reputation and a history of returning cash to shareholders through special dividends and ordinary dividends. Management is looking to move to a progressive ordinary dividend and will accelerate return of cash to shareholders. 

Catalyst

Continued cash flow generation from recovering large stones.