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Kimberley Diamonds Ltd: A lesson for investors

The collapse into administration this week of tiny diamond miner Kimberley Diamonds Ltd (ASX: KDL) holds several lessons for investors looking to play in small ASX-listed resource stocks.

For one – you’re likely to get your hands burnt.

Kimberley Diamonds suspended operations at its Ellendale Diamond Mine and placed its subsidiary Kimberley Diamond Company (KDC), the holder of the Ellendale mining licence into voluntary administration. The company blamed lower recovered grades and lower size distributions along with significantly lower realised prices at a diamond auction held in Antwerp, Belgium. Ellendale once produced half of the world’s rare yellow diamonds.

Kimberley managing director Noel Halgreen reported that KDC was unable to continue trading solvently, but the voluntary administration doesn’t apply to the rest of Kimberley Diamonds and its other subsidiaries, nor its interests in the Lerala Diamond Mine in Botswana or the Lomero-Poyatos project in Spain.

Interestingly, the announcement came just one day after the company announced that it had secured debt funding of $10 million from Zhejiang Huitong Auction Co Ltd to re-commission the Lerala Diamond Mine. Mr Halgreen says the mine will provide significant revenue streams for approximately 7 years, with ‘significant potential for extension’.

On the face of it, it sounds like a mining company struggling to make one mine profitable while being lucky to be able to re-commission another mine. However, a sceptical investor might consider the timing of the announcements to be ‘more than a coincidence’.

Here are several other issues that might be of concern:

The West Australian reports that the company registered a $1.9 million secured debt over the assets of the collapsed diamond mine just a month before it collapsed. That means Kimberley Diamonds (KDL) ranks ahead of the mine’s contractors when any money raised from asset sales is paid out. Unsecured creditors are owed around $13.5 million, while two of Ellendale’s subsidiaries (Royell and Kimroy)are also owed $17.5 million. Around 100 workers have reportedly not been paid following the mine closure. Administrators say that employees were priority creditors and would be paid first.

The newspaper also reports that the June sale of vehicles and plant from Ellendale is also being investigated.

The state government is owed around $750,000 in March-quarter royalty payments, with Kimberley Diamonds reported to have made late payments of royalties four times in the past two years.

A $30 million environmental rehabilitation liability is likely to fall onto the state’s Mining Rehabilitation Fund. Kimberley Diamonds used $10.6 million of its $12.2 million environmental bond in 2013 to repay an existing loan to a UK-listed company Gem Diamonds.

So the company plans to move operations to its Lerala mine in Africa, leaving behind a trail of destruction, including workers with unpaid wages.

Ellendale’s plant manager Bruce Vermey has told ABC News he’s owed around 125,000, but is not confident he will get it. Another mine worker, Mick Ratcliffe said he was owed $30,000 and added,

“The chairman of the board and his cohort have a lot of explaining to do because it has left a lot of people well and truly down the creek. They knew months ago that this was going to close on the 30th June, because they told people they had made redundant two months ago they would get their payments on the 30th of June.”

Transport contractor Don Dunbar has also told ABC News that he was owed a significant amount of money, but he still has to pay his drivers. Mr Dunbar bused workers to and from the site and the Curtin air base. The West Australian speculates that a host of unpaid contractors will go bust – putting more people out of work and adding to the state’s unemployed.

In 2012, Kimberley Diamonds (then Goodrich Resources) acquired Kimberley Diamonds for $14.3 million, with a then remaining mine life of 18 months. That consisted of a $3.1 million upfront payment and $11.2 million payable over time from cash flow. Receiving $12.2 million from the environmental bond proceeds virtually meant Goodrich acquired Kimberley Diamonds and the Ellendale mine for $3.1 million, and had virtually no rehabilitation liability.

Clearly, the company knew early on that Ellendale had a short mine life, unless it could find more diamonds and even then, was only forecasting an additional six months life of mine.

Then in March 2013, Kimberley Diamonds forecast it would make $11.5 million, but that was based on expectations that Tiffany would agree to big price rises. Tiffany & Co had an exclusive offtake agreement for fancy yellow diamonds, but the jeweller had already agreed to price increases in September 2012 and wasn’t going to do so again. KDL was forced to cut its forecasts.

Shortly after, in May 2014, both Chief Financial Officer Stephen Wetherall and KDL’s production manager Gideon Scheepers resigned after nine months and 12 months’ terms respectively. In retrospect, that appears to have been the writing on the wall, and one might wonder if the company was compliant with its ASX listing rules regarding the disclosure of material information at the time.

On April 1 this year, Kimberley Diamonds announced that Ellendale would continue operating in the 2016 financial year, due to cost cutting, operational efficiency and the impact of a lower Australian dollar. But that appears to have been another misleading announcement. A bad April Fool’s joke?

Foolish takeaway

One also has to wonder whether the company will actually get its Lerala mine into production, and if so will the end result be like KDC and Ellendale – leaving unemployed, unpaid workers and contractors, a mine site in need of rehabilitation and large debts behind.

This is a lesson for those who think investing in small cap resources stocks is easy. Unless you are very familiar with management and the operations, you might want to think twice before risking your hard earned cash.

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Motley Fool contributor Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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