Rio Tinto Bets On China For The Future Of Its Diamonds Business

Rio Tinto (NYSE:RIO) seems to be betting heavily on the Chinese market for its diamonds business. This week in Hong Kong, the company is hosting an exclusive viewing of its pink diamonds extracted from the Argyle mine. The viewing is by invitation only and around 100 guests have been selected for the same, including jewelry makers, connoisseurs, collectors and investors. The viewing is a part of the Argyle Pink Diamond Tender event which comprises the best of a year’s production of pink diamonds from the Argyle mine in Western Australia.

While Rio had earlier been looking for a buyer for its diamonds business for more than a year, in the absence of the right suitor it decided to scrap the plan in June. The effort to tap the Chinese market seems to be a part of the larger strategy to tap the North American and Asian markets over the medium and long term even though these markets are sluggish right now. Rio articulated its decision to focus on these two regions and considers the Chinese desire for diamonds and its emerging middle class as keys to success in this market. ((Rio Tinto opts to retain diamonds businesses, Rio Tinto Press Release))

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The Opportunity In China

According to the CEO of Rio’s diamonds and minerals division, China represents about 5% of its market right now. However, he thinks that a burgeoning and aspiring middle class may well result in China accounting for about 20% of the market through 2020. The opportunity is substantial because the Chinese buy not just diamond-studded engagements rings but also diamond fashion jewelry for themselves. In order to tap this opportunity, Rio has already partnered with the Chow Tai Fook Jewelry Group which makes Rio’s jewelry and gems available across its 1,000 stores in the greater China region. ^[1]

The validation for Rio’s estimates about the potential of the Chinese market is provided by the double-digit year-over-year growth it has witnessed for its flagship Australian Colors diamond collection which was launched at the World Expo in Shanghai in 2010.

China is also a perfect fit for Rio’s production from its Argyle diamond mines. The region is typically known for the small volumes of the rare pink diamonds it produces. However, pink diamonds comprise just 0.01% of Argyle’s total production. It produces large volumes of affordable commercial diamonds which are ideal for use in fashion accessories of the kind the emerging Chinese middle class is demanding. In April this year, Rio opened a new Argyle underground mine which will boost the average annual production from the region to around 20 million carats and also extend the mining potential of the region to 2020. ^[2]

The viewing event in Hong Kong will have on display 64 diamonds with a combined weight of 54.99 carats. Of these, 58 are pink diamonds while there are three blue and three red diamonds of an extremely rare variety. Pink diamonds, owing to their rarity, sell for more than $1 million per carat.

The Future Of Rio’s Diamond Business

The natural resources sector is sluggish at the moment due to slower economic growth in key emerging markets. The diamond business generated a loss of $43 million for Rio in 2012 compared to a net profit of $10 million in 2011. This was due to lower prices, which in turn was a function of lower demand from key Asian and North American markets.

We think that the push to develop robust diamond markets in Asia, especially China, could be a part of Rio’s strategy to eventually make a compelling case for acquisition by specialized players in the business. While the diamonds business is intrinsically a good one, it makes little sense for a company of Rio’s scale and nature. It is too small to be of strategic significance to the company and provides little by way of diversification to its bread-and-butter iron-ore business. Also, good quality diamond mines are very difficult to come by these days and their development involves a long gestation period. The limit to scalability was one of the reasons Rio was looking to sell off the business in the first place. It eats into management’s time and company resources would be better channeled elsewhere in light of the tough times Rio is facing right now.

We have a Trefis price estimate of $55 for Rio Tinto.

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1. Hand-picked guests gather in Hong Kong to see rare pink diamonds, Reuters [↩]
2. Rio Tinto opens underground Argyle mine, Professional Jeweler [↩]