Spec Value Hunter Comment - May 28, 2012: Peregrine's Chidliak qualifies as a Big Anomaly and Big Sleeper diamond play
Peregrine Diamonds Ltd was recommended a Good Relative Spec Value Buy at $0.59 on December 30, 2011 based on its 100% ownership of the Chidliak diamond district on southern Baffin Island where 59 kimberlites have been found since 2008 by Peregrine and its former partner BHP Billiton. Peregrine was the subject of intense KRO coverage from 2008 onwards on the speculation that the Chidliak diamond field had a scale comparable to that of Ekati in the NWT where BHP eventually bought out Dia Met Minerals for an implied project value of $2.1 billion. Between 2008-2011 the joint venture discovered 59 kimberlites, of which seven are deemed to have economic potential (CH1, CH6, CH7, Ch28, CH31, CH44 and CH45). All of these pipes are less than 2 hectare in size except CH31 which has a 5 hectare surface expression that represents a potential footprint of 20-30 million tonnes to a depth of 300 m. During 2011 BHP emphasized exploration of geophysical targets at least 3 hectares in size; no such targets were confirmed as kimberlites, though six small targets less than 1 hectare in size were confirmed as kimberlites, some of them with high macro grade potential based on micro diamond results. A 4.12 tonne core sample from CH31 yielded a disappointing grade of 7 cpht, and did not duplicate the 1.15 carat stone recovered in 2010 from an 850 kg sample, though Peregrine's independent expert Johann Ferreira is not yet convinced that what we have seen is all we can get from CH31. BHP's apparent conclusion was that Chidliak did not host the large, high grade kimberlites needed to support an overall resource of at least 100 million carats which had been suggested was BHP's minimum threshold to develop a new diamond mine. Peregrine management's understanding was that in this event the 49:51 joint venture between Peregrine and BHP would focus 2012 on bulk sampling the most promising kimberlites to establish carat value for a cluster of pipes that might not have world class status, but might still end up being worth a billion or so. To make sure it could fund its share of the proposed $25 million 2012 program Peregrine undertook a rights offering in Q4 of 2012 at a discount to market that had a disastrous outcome.
During late November 2011 while Peregrine was in the final week of its $0.85 rights offering BHP announced a strategic decision to divest itself of its diamond division, which included the Ekati Mine and Chidliak. The BHP bombshell, coming during what had proven to be a difficult year for resource stocks from May onwards, sabotaged the $12 million rights offerings, with the result that only $6 million was raised, largely from stiff-upper-lipped insiders. The timing of the BHP announcement was peculiar because it had been rumored for several years that BHP was contemplating the sale of Ekati, so why at that crucial moment when Eric Friedland was trying to close a rights offering; the explanation offered was that the timing decision emanated from BHP's legal department, with the implication that an Ekati sale was imminent. Six months later no Ekati deal has materialized, but during the weeks following the torpedoed rights offering Peregrine negotiated a deal to acquire BHP's 51% Chidliak stake, into which BHP had invested more than $40 million, for $9 million cash over 3 years and a 2% royalty. Given the spin that BHP had decided diamonds were too small and complicated a market for a major mining company focused on iron, coal, potash and copper, and that Peregrine was simply corporate roadkill, an argument could be made that Peregrine got lucky getting back 100% of a project with a dream target potential in excess of $500 million. The market, however, has chosen to view the glass as half empty, and is currently assigning an implied project value of only $75 million based on 123.7 million shares fully diluted and a 100% net interest. For Spec Value Hunters who held Peregrine during the initial Chidliak exploration cycle the current situation is not a happy one, but for newcomers it is a classic Spec Value Hunter opportunity which offers Big Anomaly and Big Sleeper upside.
Peregrine plans to spend $10 million on Chidliak during 2012 starting in July which will delineate the CH7 and CH1 kimberlites as preparation for a bulk sampling program in 2013 for CH1, CH6 and CH7, test more than 35 targets typically less than 2 hectares in an effort to build the carat footprint to 50 million carats through multiple small pipes, and conduct a more refined geophysical survey to make sure there are indeed no other large, subtly defined kimberlites such as CH31 at Chidliak as BHP concluded. In this regard Peregrine qualifies as a Big Anomaly and a Big Sleeper play, the first because during 2012 it could discover additional high grade pipes similar to CH6 that boost the carat footprint beyond the 30 million carats that can be inferred for CH1, CH6, and CH7, and the second because bulk sampling during 2013 could establish that the existing portfolio of pipes has an economic value approaching or exceeding $1 billion. About two-thirds of the targets are within the Southern Focus area where it is Peregrine's goal to establish a cluster of pipes with a minimum 30 million carat resource represented by high grade 100-300 cpht pipes, and possibly discover additional small high grade pipes that boost the carat potential to 50 million carats. This is the best we can hope for in Big Anomaly terms during the 2012 season; the possibility that large pipes such as CH31 remain to be found in the Southern Focus area will have to await the results of additional target generation work. The current targets will be drilled with an RC rig; the core rig will be deployed late in the season after the bulk sample preparatory delineation drilling is done if early discoveries deliver good micro diamond results, or late season discoveries yield indicator mineral rich kimberlite.
On April 2, 2012 Peregrine published a tonnage estimate for CH6 that indicates 5.7 million tonnes to a depth of 375 m. This sort of tonnage estimate is conceptual and only done for diamond deposits because macro grade alone says little about economic potential which requires a carat value based on a sufficiently large parcel of diamonds recovered through bulk sampling. Mini-bulk sampling during 2010 established grades of 681, 349, 282 and 203 cpht for four distinct units within the CH6 pipe. In its technical report Peregrine does not formally match the kimberlite unit tonnages with the mini bulk sample grades, but based on prior disclosures one can make the matches. The only guess I have made is that the "weathered kimberlite" at the top of the pipe, which is estimated to have 317,030 tonnes, has the same grade as the underlying Kimberlite A unit, namely 681 cpht. On this basis the CH6 pipe has a conceptual resource of 5,731,425 tonnes with an average grade of 354 cpht representing 20.3 million carats.
Conceptual Potential for Kimberlite CH6
|Kimberlite Unit||Tonnage||Sample Grade cpht||In Situ Carats|
|Kimberlite Unit A||837,725||681||5,704,907|
|Kimberlite Unit B||1,961,968||282||5.532.750|
|Kimberlite Unit C||1,094,990||349||3,821,515|
|Kimberlite Unit D||1,519,712||203||2,158,974|
|Note: the mapping of unit tonnage to sample grade was done by John Kaiser after analysis of separate company disclosures which do not formally relate sample grades with unit tonnages.|
In December 2010 independent expert Howard Coopersmith was quoted in the CH6 mini bulk sample news release as follows: "over all, CH6 shows an exceptional white diamond population, with high clarity and many superior shapes present. There are indications of fancy yellow stones as well, and very few browns or greys. It is expected that larger parcels of CH6 diamonds would produce valuations comparable to better quality kimberlite diamond mines in the world". Peregrine has not done a valuation of the CH6 diamonds because the 40.04 carat parcel consisting of 523 diamonds bigger than a 0.85 mm sieve is too small to yield a statistically meaningful carat value. However, if Howard Coopersmith's observations are reliable, and I have no reason to believe otherwise, the CH6 diamonds would average at least $100 per carat, which implies a rock value of $354 per tonne and in situ value of $2 billion for CH6. The big unknown is what happens to the size and quality of the diamonds in a much larger parcel. Will the size and quality hit a limit at the 10.8 carat special boundary as is the case at Diavik for whose high grade the price seems to have been a paucity of big gems of the sort Tiffany desired, or will the population have a potential for large, high quality diamonds as appears to be the case at Gahcho Kue so that a modeled upper limit might approach $200 per carat, implying an open-pittable $4 billion deposit with a $700 rock value? Furthermore, how much additional tonnage will eventually be generated by the dyke-like "string of pearls" with which the CH6 kimberlite is associated? The answer to this Big Sleeper question will not be known until a bulk sample that recovers at least 200 carats from CH6 has been completed. The project carat footprint reaches 30 million carat when we include CH7, a 1 hectare pipe with a mini bulk sampled grade of 104 cpht which has conceptual potential of 5 million tonnes to a depth of 300 m, CH1, a multi-phased kimberlite with a complex geometry for which only the lowest grade unit appears to have been mini bulk sampled, and the smallish CH44 and CH45 kimberlites which have macro grade potential of 100 cpht plus based on micro diamond results.
Spec Value Hunters may also receive a surprise bonus during the next couple months when Peregrine receives the micro diamond results for 3 kimberlites discovered in the Lac de Gras area of the Northwest Territories through a winter drill program. All three were generated as geophysical targets with 1 hectare surface expressions. LD1 is on 100% owned ground 12 km west of Diavik, LD2 is 2.5 km west of the DO27 pipe on 71.9% owned ground, and LD3 is 7 km southwest of DO27 on 100% owned ground. The small sizes of these pipes rule out much of a market reaction if they yield micro diamond curves suggesting macro grade potential of 100 cpht plus, but success on this front could contribute to bringing the DO27 pipe closer to economic viability. More than $50 million has been sunk into DO27 whose grade, tonnage and carat value fall short of the critical masss needed for a standalone diamond mine in this part of the Arctic. Peregrine does not plan to follow up during 2012 even if the results are good, but good results could reopen the Lac de Gras front as a value creator for Peregrine.
Conclusion: Peregrine Diamonds Ltd represents good relative spec value at $0.59 with regard to its 100% owned Chidliak diamond project where sufficient work has been done to outline potential for a diamond resource approaching 30 million carats, with 20 million carats residing in the high grade CH6 pipe. The stock is under consistent accumulation by insiders who are confident that Chidliak will become a diamond mine. What is not known is the final scale of the Chidliak Mine. Spec Value Hunters need to be patient because advanced work involving a bulk sample has been postponed until 2013, and will be subject to financing. The 2012 exploration season, however, has the potential to recapture the market's imagination because Peregrine is focused on testing a large number of targets similar in size to CH6 and CH7 that could take the story beyond a Renard scale project if new discoveries prove to be high grade. Spec Value Hunters should buy now for an eruption of Big Anomaly speculation an hold for Big Sleeper confirmation. The planned divestitures by BHP and Rio Tinto of their diamond divisions, either through a sale to a new group that takes the asset public, or through floating an IPO as some think Rio Tinto is contemplating, would inject new life into the diamond sector by creating several medium sized diamond producers whose goal is to grow their business, incrementally through acquisition of "successes" that fall short of world class status, if necessary. My hope, of course, is that Chidliak yields new discoveries that put it back into a world class category, this time owned by a junior which does not have to worry about a major's ever-rising minimum threshold. That possibility exists, but my primary hope is that during the next 12 months Peregrine regains sufficient market momentum to avoid having to conduct a dilutionary farmout that puts it right back into the position it was when BHP was its partner. The 2012 summer program will deplete Peregrine's treasury, so good exploration discovery news or an improved market attitude toward the diamond sector is needed to put Peregrine back into an uptrend, one that enables management to finance the 2013 bulk sample at considerably less dilution than created by a farmout.
*JK owns shares in Peregrine Diamonds Ltd