SRM.V offers a good risk/reward option for patient investors.

This article was originally sent to TickerTrax subscribers on Feb 17, 2011.

Shear Diamonds (SRM.V $0.55)
www.shearminerals.com

Shares Outstanding: 42 million
Market Cap: $23 million
Net cash approx. $8 million

The diamond sector has been quiet for years and the risk is that it remains that way. Without big discoveries somewhere, it’s tough to generate interest. That being said, we have no diamond exposure so I have been looking for one that presents an attractive risk/reward keeping in mind it could become dead money for a while.

I have been researching Shear Diamonds Ltd. (TSX: V.SRM, Stock Forum) and really like what I see in the $0.50’s because a person can come in after-the-fact on a cleaned up share structure that was previously a mess.

In 2010 Shear acquired a past producing diamond mine in Canada's far north (Jericho) and they also have a massive land position. None of this came without a cost over the years. They issued paper like the U.S. government and had over 400 million shares outstanding.

In December they completed a 10:1 rollback (painful for old shareholders) and now have about 42 million shares outstanding. As it now stands, at $0.55 the market cap is $23 million but they also have $8 million in the bank. This means the diamond project and the massive land position is being valued at $15 million. Very undervalued even when the sector is quiet. The table below is from their most recent corporate presentation.

Shear was a grassroots diamond exploration company until August 2010 when they purchased (under a court-sanctioned transaction) the Jericho project Nunavut.

The 100% owned Jericho was a past producing open pit mine with an existing resource of 1.88 million carats indicated, and 1.13 million in the inferred category. Opportunity exists to increase the resource at depth and from adjacent kimberlite pipes. The existing pit has only been delineated to 190 metres depth.

Approx. $200 million was previously spent on mine infrastructure and only moderate re-investment is required.

There is excellent potential to expand the resource base.
Re-engineering studies have been completed and they indicate that past operational issues can be resolved and substantial improvement opportunities exist. These include: reducing the material rehandling from 2-3 times to 1 time, crushing and sorting improvements, increase overall diamond recoveries, and establish formal plant maintenance. Its no wonder the previous owners ran into financial trouble if they didn’t even maintain a proper maintenance plan.

Between Jan 2006 and May 2008 the previous owners mined 13.6 million tones of material. This contained 1.2 Mt of kimberlite processed with 780,000 cts recovered.

The mine has produced 1000 stones > 10 carats in size and one 59 carat gem sold for $450,000. There are currently no marketing agreements in place but the previous company had agreements with Tiffany’s.

There are six known kimberlites within 10km of Jericho and the surrounding area of 68,000 acres (100% owned) has five unresolved kimberlite indicator dispersion trains and geophysical targets.

In addition to Jericho which appears grossly undervalued by the market, Shear has a portfolio of advance-stage and underexplored projects with > 120 kimberlites (source rock for diamonds).

Their Churchill Project is 62% controlled and contains 600,000 acres in Nunavut with 88 identified kimberlites. The Great Bear project is 50 to 100 percent owned and contains 112,000 acres in the NWT with 20 known kimberlites.

Long story short, if we pull out the cash, the market at $0.55 assigns a value of $15 million to Jericho and their huge land position of exploration targets. Few are paying attention to the junior diamond stocks and while this may not turn overnight, it doesn’t mean the demand for diamonds isn’t there.

On February 16th De Beers stated they are seeing extraordinary growth in China and India.

“The Diamond Price Index is up almost 10 percent in 12 months, the biggest year-over-year increase since 2008, according to Morgan Stanley and the International Diamond Exchange. De Beers, the world’s biggest producer, said last week that prices for rough diamonds increased by 27 percent in 2010 to levels higher than before the global financial crisis. Diamonds, which do not trade on an exchange, are simply mirroring the explosion in prices of other commodities” [CNBC Feb 16th]