Why Is Rio Tinto Pushing Into The Indian Diamond Market?

Rio Tinto (NYSE:RIO) has set its sights on capturing a large chunk of the Indian marriage gifting market with its ‘Nazrana’ brand of diamond jewelry. The Indian marriage market is huge for jewelry makers and offers a fantastic opportunity to provide fashion jewelry as gifts, beyond the traditional set pieces worn by the Indian bride. According to Rio’s own estimates, the size of the market for wedding gifts in the country is around Rs.10,000 crore. ($1.8 billion). ^[1]

As the third largest producer of diamonds in the world, we think that it makes sense for Rio to actively promote development of markets for its produce. Indeed, the company has a dedicated Sales and Marketing division which works with Rio’s customers to promote the profile of its diamonds. Its business model involves selling rough diamonds to the diamond trade and providing tailored support to its customers for their downstream sales and marketing initiatives. ((Marketing and support for our customers’ downstream sales initiatives, Rio Tinto Diamonds))

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Why Is India An Attractive Market?

There has always been an inherent fascination among Indians and Chinese for precious gems, particularly diamonds. Economic growth has taken off in a big way in these two Asian giants in the last two decades. This has created an affluent class of people with huge disposable incomes. This class is now eager to gain status in society by spending on luxury items. We think that the pivot of economic growth for the future has irrevocably shifted towards the East, in particular Asia. As the Indian and Chinese societies continue to become more affluent, we believe that there will be more demand for diamonds and prices will appreciate. ((China, India to fuel demand for diamonds, says Rio Tinto, Economic Times))

Add to that the fact that no new major diamond mines have come up for years. This is bound to cause a demand-supply gap in countries like India. Even if a new mine is identified, it takes 5-7 years for the mine to start producing diamonds. With little reason to believe that the situation is going to get any better in the future, high prices will be here to stay. These will result in huge profit margins for companies like Rio Tinto which own great mining assets.

Wait, Isn’t Rio Looking To Exit The Diamond Business?

After a strategic review in March this year, Rio announced its intention of selling its diamond business. While admitting that the market conditions for the diamond business are quite favorable owing to tight supplies and burgeoning demand from China and India, the company said that its focus was on businesses with large, long-life, expandable assets. As already mentioned, the scope for expansion in the diamond business is limited because of fewer discoveries, if any, of major deposits in the last decade. It is also quite a task to grow inorganically through acquisitions because of the small size of most diamond miners. We believe this is the key reason why Rio wants to get out of this business. Its capital would be better deployed in businesses which provide more scope for expansion and future growth. ((Rio Tinto to sell diamond business, The Telegraph))

So why is Rio taking so much interest in developing a business it anyways intends to sell?

We believe this is because Rio wants to drive up market valuations for its diamond business. Although both its diamond and aluminum businesses are on the block, Rio has said that it is in no hurry to sell them and would rather wait for the right price. The diamond business is a fundamentally strong business for all the reasons mentioned above. While it may not fit into Rio’s overall strategy and vision, it may be a good fit for some other company’s business. Therefore, we think that it makes sense for Rio to invest time and effort in developing the business before exiting it. Rio’s efforts also serve the purpose of sending periodic signals to potential buyers that there is ample scope for further development if they were to bid for the business. We think that Rio’s continued interest in the Bunder project in India is meant to be one such signal.

The diamond business constitutes only 4% of Rio’s Trefis price estimate, so we don’t expect the success of the Bunder project to have a significant impact on the company’s overall valuation.

We recently revised the Trefis price estimate for Rio to $45 which is nearly 11% below its market price.

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1. Rio Tinto eyes marriage gifting market in India, Economic Times [↩]