If you bought shares of Yorkshire potash miner Sirius Minerals (LSE: SXX) two years ago, your investment is probably still showing a loss. But if you waited until December 2016, you may now have doubled your money.
Today, I want to look at the investment case for Sirius Minerals. I’m also going to consider a small-cap stock that’s trading at a 50% discount to book value. Is this a fantastic bargain, or could things get much worse?
Why is Sirius stock so volatile?
Over the last two years, the Sirius Minerals share price has ranged between about 17p and 40p. As I write, the stock is near the top of this range, at 35p.
This kind of volatility isn’t unusual for a miner with a long development timeline and no revenue. Market sentiment swings between risk and opportunity, without the reality of profits to calm things down.
I think Sirius has made good progress so far. Sales agreements have been signed for half the mine’s planned 2024 production and construction work is on schedule. However, production isn’t expected to start until 2021. And despite having raised $1.2bn of financing in 2016, the company still needs to raise another $3bn to complete the project.
As my colleague Graham Chester explained recently, there’s still a lot that could go wrong.
When I’d buy
In my view, Sirius shares are probably nearer to a peak than a trough at the moment. They’re certainly too expensive to tempt me.
If I wanted to pick up stock to build a long-term position here, I’d be looking for an entry point of no more than 25p.
Risk vs opportunity
Shares of offshore platform operator Gulf Marine Services (LSE: GMS) fell after the company published its results this morning, but have since recovered to trade unchanged.
The firm’s half-year figures were certainly a mixed bag. Revenue of $56.1m was ahead of the $54.4m recorded during the second half of 2017. Gross profit was also higher, at $21.3m versus $16.8m during H2 2017.
This improvement has been driven by a number of new contracts. These have improved fleet utilisation from 61% at the end of 2017, to 72% at the end of June.
What could go wrong?
The big problem for shareholders is that 2019 could be a difficult year. Gulf Marine’s net debt was $409.9m at the end of June. That’s equivalent to about seven times 2018 forecast EBITDA. I’d normally look for a net debt/EBITDA multiple of no more than 2.5x for a business of this kind.
Sure enough, the company warned today that it could breach its debt covenants at the end of 2018, if new contract wins don’t come quickly enough.
This could be serious
Because market conditions are improving, I suspect Gulf Marine’s banks would be prepared to take a relaxed view if this happens. But there’s no guarantee of this. The firm could be forced to raise some fresh cash from shareholders to kick-start debt reduction.
At 44p, the shares are currently trading at a discount of more than 50% to their book value of 92p. These shares could rise rapidly if trading improves. But I’m not going to invest just yet.
Debt problems can be very costly for equity investors. For this reason, I’m going to avoid this stock until we get clear evidence that Gulf Marine is profitable and actively repaying debt.