INVESTMENT COMMENTARY — Aber shareholders in wait-and-see mode

The appointment of David Anderson as Canada’s minister of the environment has sent a wave of nervousness through the country’s fledgling diamond mining sector. In the past, Anderson has been a protester against forestry practices in British Columbia and a member of so many green groups he’s become known as the “the minister of environmentalists.”

The most nervous of all are shareholders of Aber Resources (abz-t), who are awaiting Anderson’s yea or nay on development of the company’s Diavik project in the Lac de Gras region of the Northwest Territories. A federal review panel recently sent its report to Anderson, who has yet to make any public comment.

David James, diamond analyst for Canaccord Capital, has been watching developments in Ottawa, and in Canada’s diamond industry, closer than just about anyone else. In a recent research comment, he speculated that the minister might give “a qualified go-ahead” for the project, based on the success of the nearby Ekati diamond mine, which has been operating for about a year. However, a positive nod would almost certainly be accompanied by conditions that would have to be met before construction could begin.

Aber’s share price has been volatile of late, particularly since the release of a feasibility study that showed capital costs would be higher than expected, with production startup delayed by at least one year. Operating costs were also found to be higher than forecast.

Roger Chaplin of T. Hoare Canaccord has also been following Aber’s trials and tribulations closely. In a late September report, he stressed that despite the negative points in the prefeasibility study, “the Diavik project is still economic.” Accordingly, he rated the company “a buy.”

Chaplin is particularly bullish about the company’s long-term outlook. “If Aber is valued on the same basis as Dia Met once the Diavik mine is up and running, then its share price should approximately double over the next three years to around $20 — a compound growth rate of around 25% per annum.” (Dia Met Minerals [dmm-t] is the 29% owner of Ekati.)

Without minimizing the higher costs and late start at Diavik, Chaplin bases his optimism on the fact that there has been no change in the overall reserves announced in 1998. These stand at 25.6 million tonnes grading 3.96 carat per tonne, for a total of 101.5 million carats.

“These reserves have an in situ value of approximately US$5.6 billion,” he noted, “which still gives an overall operating profit margin of approximately 75%, and net profits over the mine life (after capex but before tax) of more than 50%.”

The minable reserves include only measured and indicated resources to 420 metres below surface. Chaplin noted that there are additional resources of 12.5 million tonnes grading 2.38 carat per tonne, or 30 million carats, which may eventually be brought into the mining plan. “These have an additional in situ value of around US$1.7 billion.”

The biggest shock in the feasibility study was the 50% increase in capital costs to $1.2 billion from $875 million. A further $263 million will be required in years 2006-2010 to build additional water-retention dykes, plus $45 million for underground development.

Startup, originally planned for the second quarter of 2002, has been postponed to the first half of 2003, and the annual mining rate has been reduced to 1.5 million tonnes from 2 million tonnes.

“The cash operating costs are now estimated to be $85 per tonne over the first ten years of mine operations (excluding the two years ramping-up of production),” Chaplin noted. “The prefeasibility study looked for cash costs of $66 per tonne over the life of mine, so the new estimate is an increase of almost 30%. Some of the increase may be due to the lower mining rate, as fixed costs for such a remote project will form a considerable portion of the total costs.”

Diavik’s higher capital costs, relative to Ekati’s $700 million, in part reflects the need to build water-retention dykes around the kimberlite pipes in the mining plan. These pipes are in a large lake, and engineering must be of the highest standard to ensure no failures will occur. In contrast, the pipes at Ekati needed only a limited amount of work to drain shallow lakes.