Event

We are initiating coverage on Stornoway Diamonds with a recommendation of

Outperform, Speculative Risk.

Investment Opinion

Renard: Canada's next diamond mine

We believe a mine on Renard is virtually assured. Geological and financial data

suggest production in excess of 1m carats of diamonds per year from 2013,

peaking at 1.6m ct/year in 2016/17 with a mine life of over 25 years.

The outlook for rough diamond prices remains good

Our analysis of the likely supply of rough diamonds over the next five to ten

years suggests that there could be shortages in certain areas of the market,

particularly if China continues to grow its market share in the jewellery market.

Shorter term, the risk is that rough prices have risen too far too fast.

Capital and opex estimates point to sound IRR

We have modeled Renard using a DCF (8%) model and come to a valuation for

Stornoway's 50% of the project (the Quebec government owns the rest) of $313m

with a post-tax IRR of 21%. Our input assumptions differ from the company's

only in so far as we have modeled a higher second-year rough diamond price in

line with our forecasts for other diamond producers.

Renard valuation sensitive to rough diamond prices

The valuation is sensitive to rough diamond prices. Boosting our diamond price

escalation by 1% per year or a 10% higher starting price would increase our

Target Price ~20%.

Target Price based on 0.7x NAV

Our DCF valuation of Renard forms the bulk of our valuation. In setting our price

target at
.90/share we have used a 0.75x price:NAV multiple which is the same

as we use for other developing projects. For producing mines we use a 1x NAV

multiple suggesting an expanding multiple as production approaches.

Investment Conclusion

We view prospects for rough diamond prices favourably and our investment

stance continues to prefer companies already producing or those near to

production over explorers. We believe Stornoway offers one of the better ways to

gain exposure to a project close to production and should benefit from an

expanding valuation multiple as the green light is given to the project and the

commencement of mining approaches.