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I have been following Sirius Minerals for a while, I never though quite got around to doing my research. This clearly has cost me, but is it too late to jump on the bandwagon or should those lucky investors who got in earlier be looking to bank profits?
Sirius have a fully consented Polyhalite (POLY4) mine, which is a used as a fertiliser, this touted as a superior product to that of the only British Potash mine which closed this week with a loss of jobs. Sirius’ project is ready to go with the contractors ready put spade in ground, subject to financing. The base case project NPV is $15bn, slipping to $10bn with a 20% reduction in POLY4 price and 20% increase in CAPEX. This compares to £960m market capitalisation, or $1.25bn. This then on paper presents considerable upside.
The NPVs quoted above is Sirius’ project NPV though, not the company NPV. The debt financing and plc costs I have calculated to reduce NPV by around $750m-$1bn. So plenty of headroom and I have assumed a return for the note holders of 10% a year.
The fundamentals for the product look good here, there is a global need to maintain good soil quality and increase crop yields. The traditional potash price though has collapsed though since 2009 falling by 50% mainly due to increased supply. However, POLY4 is a premium product, it contains more nutrients and requires less processing and it relatively rare. I can’t see much risk on the demand for Poly4, however oversupply of traditional potash may also put pressure the Poly4 price but as mentioned above there the economics look good even with a 20% reduction in price. It is also worth noting that the company already has take or pay offtake agreements in place for 80% of the expected initial production of 10 Mt.
Sirius also appears to be very transparent, including lots of information which make it easy for investors to make a fair assessment of the company.
Looking at the broker opinions, Shore Capital has recently upgraded it’s share price to 75p, with further gains expected as the project becomes de-risked. Shore capital is not the house broker so you can actually take the target reasonably seriously. The stock is not well covered though, Shore Capital is the only broker covering Sirius (with the exception of the house brokers).
So should I jump in?
It does sound as though there is plenty of upside but what are the risks?
As mentioned above the project is ready to go but needs financing. The project looks very appealing but with less than a month to execution stage I am concerned that no financing is in place yet. Sirius’ auditor have also noted the going concern issue around the financing through their ’emphasis of matter’ on the interims, probably more ‘arse covering’ than any major concern but it does highlight the risk here. The questions I have are. Why has the financing taken so long? What has been the interest from the finance houses? What are the expected finance costs, Sirius Minerals must have an idea of the spread?
It is fairly unusual for a junior exploration company to take a major resource discovery all the way through to production. They are normally snapped up by bigger players, who have the expertise and can finance projects of this scale. Why have none of the big commodity players moved in for this project? One possible answer is that many of the big players are currently focusing on reducing Net Debt, so a project of this scale may not be attractive despite the positive IRR. Was there a data room at any stage though? Even to bring in a JV partner? If there was why was there no interest?
Another issue to consider is that this is a major EPC project and there is always a risk of significant overruns. HSE issues or engineering challenges being possible contributing factors.
The project requires an upfront investment of $2.9bn and free cashflow is unlikely before 2022. Therefore it will be a long time before you will see dividends, there is also a risk that some investors will lose interest and capital growth may take some time too.
SPECULATIVE BUY – Target 50p
I won’t be placing an order for Sirius stock as I am already overweight on junior stocks but I will look to take a position in the future. The stock has had a good run and there does look like being further upside from here, if everything goes to plan.
The elephants in the room for me though are why we have not seen any hint of M&A activity and why the financing has taken so long to get going. Those who have been following Sirius Minerals longer may be able to help me answer these questions so please feel free to post in the comments section.