I’ve been mightily impressed by the way Sirius Minerals (LSE: SXX) has progressed its project to develop a giant polyhalite mine under the North York Moors. Negotiating the multi-jurisdictional permissions for the mine and its associated infrastructure was a feat in itself and securing $1.2bn for the first stage of construction was equally impressive.
The progress has seen Sirius move from London’s junior AIM market to the Main Market. It now sits in the FTSE 250 index with a market capitalisation of £1.7bn at a current share price of 36p. Is there still good value on offer for investors today or could the shares be heading for a crash?
Margin of safety
I’ve written positively in the past about the investment opportunity of this unique project with an expected mine life in excess of 100 years. My valuation was based on Sirius achieving its target of 20 million tonnes per annum (Mtpa) by 2027, a price of $145 per tonne and an EBITDA margin at the midpoint of the company’s projected 70% and 85%.
Together with some other assumptions, including a valuation of 10 times EBITDA and a settled net debt/EBITDA ratio of two, I calculated a potential compound annual growth rate (CAGR) of the share price through to 2027 of as much as 30%. I viewed this as offering a good margin of safety for investors. However, these calculations were at lower share prices — for example, 22.2p when I last wrote about the company in January.
I’m revisiting my valuation today not only in light of the current significantly higher share price, but also because I have some concerns about the price Sirius’s multi-nutrient polyhalite product might command and the size of the market for it.
Problematic
In looking at a modestly less successful outcome by 2027, I’ve taken demand as being met when production reaches 13 Mtpa (Sirius’s target before stepping up to 20 Mtpa), sold at $125 per tonne and at an EBITDA margin of 70%. My calculations produce a market capitalisation come 2027 of around $8.65bn (£6.7bn). This equates to a share price of 118p, assuming minimal further shareholder dilution from the current 5.7bn total of issued and contingently issuable shares. On this basis, the share price CAGR from today’s 36p through to 118p in 2027 works out at a bit below 15%.
I’d happily buy shares in a well-established business on such a projected return, but Sirius is more problematic. In particular, it has not yet secured the $3bn stage two financing it needs to complete construction and bring the mine into production.
Crunch time
The company is hoping to announce stage two financing by the end of the year, in the form of $1bn commercial borrowings and $2bn of UK taxpayer money. It remains to be seen whether Sirius’s potential lenders have any concerns about the aforementioned size of the market for polyhalite as well as the quality of the company’s current off-take agreements — subjects discussed in some depth in a Financial Times article last month.
I find it difficult to see Sirius failing to get a deal, but I do see a risk of a dilutive equity fundraising being a part of it. In such circumstances, I don’t think it would be far-fetched to think that dilution and sentiment could cause the share price to crash 50%. Reluctantly, I’m inclined to rate the stock a ‘sell’ at the current level.