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This Undervalued Miner Could Be Perfect For Your Portfolio

Daniel Cross

Science -- it's responsible for everything we take for granted these days. 

We trade on global platforms made possible by scientific innovations. Companies constantly look for new ways to stay competitive by taking advantage of new technologies and more efficient processes. From telecommunications to green energy to agriculture, scientific breakthroughs have advanced human knowledge, increased workers' productivity and allowed us to create a world that until recently would've seemed the stuff of fiction.

Before the technological revolution, though, there was another branch of science dedicated to the idea of making money from nothing. It was called alchemy. Using a legendary substance known as the philosopher's stone, alchemists believed they could transform lead into gold. 

As farfetched as it might sound, the idea turned out to have some valid scientific basis. Lead has an atomic number of 82 while gold's is 79. Before you dismiss the idea as pure quackery, the same transformation occurs naturally in nature in the form of radioactive decay. 

In fact, just recently, a team of scientists were actually able to accomplish the alchemists' dream of turning lead into gold. Before you think about creating a lead portfolio, it took the use of a particle accelerator and huge amounts of energy to break lead down into gold -- and the resulting amount of gold was so small, even a mass spectrometer was unable to identify stable forms of the precious metal. 

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So how about a different form of alchemy -- transforming coal into diamonds? Unfortunately, that's also a myth: The only similarity between diamonds and coal is the fact that they both contain carbon, just stacked differently. 

So considering the near-impossibility of performing transmutation on nature, why not just mine diamonds? After all, the diamond business might be the real philosopher's stone investors are looking for. 

Long-term fundamentals for the industry are bright with new reserves unable to replace production depletions fast enough and long lead times for new mines. Like many sectors, overseas demand will be the driving force for growth. By 2020, China's demand for diamonds is expected to grow from 5% to 21% of the world's total market demand while India's should increase from around 5% to 12%. 

The company that's preparing for this boom is Toronto-based Dominion Diamond Corp. (NYSE: DDC). Dominion acquired the diamond segment of BHP Billiton (NYSE: BHP) last year for $553 million and is a 40% partner with Rio Tinto's (NYSE: RIO) Diavik diamond mine in Canada. 

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For the month of April, more than 40,000 shares have been purchased by three different insiders. There have been no insider sales since January 2013. These signals are a good reason for investors to take a closer look.

In its most recent quarter, Dominion posted year-over-year revenue growth of 111%, and sales came in 6% higher than expected. Long-term growth in earnings per share (EPS) is estimated at 36%. Further, Dominion has a return on equity (ROE) of 44.9% over the past 12 months, crushing the industry average of 0.7% in that time.

However, due to the accounting treatment from the acquisition of the Ekati mine and related expenses, Dominion's margins appear skewed. If we look at the company's operating margins from 2012 to 2013, we can see that they are in fact rising -- 12% to 13%, an amount that falls more in line with industry averages. 

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Risks to Consider: Foreign exchange risks from operations around the globe could weigh on Dominion's earnings. In addition, Dominion is highly sensitive to diamond prices, which are propped up by international demand. Any weakness in emerging middle-class markets could adversely affect the stock's value.

Action to Take --> Dominion trades at a 21% discount to its book value of $15.05, and a recent sell-off has brought the stock's Relative Strength Index (RSI) reading down to 26, signaling that it may be severely oversold. There doesn't appear to be a fundamental reason for why the stock fell, so investors could buy in now at a bargain price.

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