Pressure on Diamond Midstream Likely to Increase

RAPAPORT... Diamond manufacturers will consolidate in the coming years to avoid being further squeezed by miners and retailers, Bain & Company predicted in its annual report on the industry.The forecast stems from the midstream becoming anincreasingly weak part of the supply chain while retailers and rough producers haveimproved efficiency. This has resulted in manufacturers becoming "price-takers," forced to accept sale conditions that more powerful parties have dictated, Bainpartner Olya Linde said Tuesday in an interview with Rapaport News. Retailers are increasingly demanding goods on memo andusing e-commerce options to minimize their inventory, Linde explained. At thesame time, weak consumer demand and lower diamond content in jewelry havereduced cutters' revenues, she said. Midstream polished sales dropped 10% to15% in 2019, while operating margins fell 2% to 3%, Bain estimated in the report, published Wednesday. "If you look at the structure of the diamond pipeline,there is consolidation in retail, with companies becoming bigger and havingbigger purchasing power," noted Linde, who co-authored the report. "They candictate a lot of conditions. The rough-diamond portion is also fairlyconsolidated, but the midstream is very fragmented. Therefore, they havelimited ability to enjoy the benefits of scale that could bring efficienciesand create better margins." This pressure could lead to "long-overdue" restructuring andconsolidation in the midstream, she said. "There are diamantaires that...havebuilt scale. I think that will continue to happen, and the more successful andmore innovative [companies] will probably end up winning."Credit cutbacksMeanwhile, a slumpin bank lending has contributed to lower liquidity in the cutting sector. Available financing has dropped by $5 billion, or 30%, since 2013 - with$2 billion of that decline occurring in the past two years, Linde noted. Asaccess to affordable financing became harder, cutters and polishers reducedtheir rough purchases by around 30% this year to help work down inventory andimprove cash flow, according to her report. While Bain does not predict an increase in lending in theshort term, it sees alternative financing options as a potential source ofliquidity. Hedge funds and other players are selling structured products thatguarantee stable costs over the financing period, it reported. Banks in theMiddle East are offering additional financing options as traditional lenders inIndia, Belgium and Israel move away from the diamond industry. Furthermore,investment funds with large amounts of capital are lookingclosely at the diamond trade, Linde noted. "This story of a gap in financing is one that isattractive to many, and they're definitely exploring the opportunity," shepointed out. "The biggest question is obviously valuation of diamonds and howyou valuate inventory, and how you make sure the loans are guaranteed."Inventory rebalance The other major cloud over the industry, excess inventoryin the manufacturing sector, will begin to dissipate next year, according tothe Bain report. However, an imbalance will remain, preventing a full recovery.This will be exacerbated by reduced financing, insufficient supply cuts byminers, and sluggish retail growth, it said. Industry downturns resulting from internal pipelineinefficiencies tend to last longer than those related to macroeconomicrecessions, Bain noted. In the case of the current slump, more breathing roomwill appear in 2021 as the Argyle mine in Australia closes and production fallsat the Diavik and Ekati deposits in Canada. "The industry's first and strongest opportunity torebalance and regain growth will be 2021," the report concluded. "Rough-diamondsupply is projected to decrease about 8%, and macroeconomic indicators areexpected to improve if the global recession is short-lived."Image: Rough and polished diamonds. (Ben Perry/Armoury Films/De Beers)