After falling 10% in just 3 days, I'm not catching falling knife Petra Diamonds Limited

The Motley Fool

It's been a rough year for shareholders of Petra Diamonds(LSE: PDL). Year-to-date shares in the miner have lost around 50% of their value as the company has struggled to turn its fortunes around.

And today, shareholders have been greeted with yet more bad news. The group issued a trading statement this morning warning that its risk of breaching its earnings covenants at the end of 2017 has risen due to the sensitivity to changes in diamond prices, exchange rates and expected production.

This isn't the first time the company has had to warn shareholders about the possibility of default. Back in September, management issued a statement noting that flexibility on debt facilities with covenants tied to earnings before interest, tax, depreciation and amortisation was tight, and it looks as if the situation has become tighter still since this warning.

Operational slowdown

Petra is blaming "labour disruption at three of the company's South African operations and the uncertainty around the final volume of sales for the Williamson mine in Tanzania in the first half of 2018" for its debt problems. Creditors have been alerted to the company's precarious fiscal position and management "will remain in regular engagement" with lenders to find a solution.

Still, despite the low fiscal headroom the company has left, according to today's update, management believes that the firm has sufficient liquidity from existing cash resources and operating cash flows to meet liabilities as they fall due, assuming there's no sudden, unforeseen change in circumstances.

Looking at today's update, it would appear that Petra's problems are not terminal just yet. That being said, in my view, the company is skating on thin ice. Even though management believes the company's cash resources are sufficient to keep the lights on in the near term, by being close to breaching its lending covenants, the group is dangerously close to becoming a slave to its creditors.

Rough patch

Petra's liquidity warning comes after a rough few months for the company. Last month the South African Kimberley mine was disrupted due to a labour dispute ahead of the signing of a new wage agreement. And it was forced to suspend exports from its Williamson diamond mine in Tanzania after the government seized a parcel of diamonds from the mine, declaring it was undervalued. Both of these issues have now been resolved. The labour dispute concluded at the end of September, and the Williamson mine is back in operation.

Nonetheless, while these headwinds may now be behind the firm, their impact on the business is still being felt. Petra now has very little room for manoeuvre if it has to deal with any more unforeseen stoppages and for this reason, I believe that the company is not an attractive investment.

City forecasts have the shares trading at a forward P/E of 9, which may seem cheap, but to me, this valuation seems appropriate considering the risks facing the company.

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Petra is struggling to turn itself around, and for this reason, I would avoid the company.

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Rupert Hargreaves does not own any share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.