Investing in early stage mining stocks is almost always a roller coaster experience. Even the best companies have ups and downs.
In this way, Sirius Minerals (LSE: SXX) isn’t that unusual. So far this year, the firm’s shares have risen from 23p to 39p — and then fallen back down again. At the time of writing, Sirius stock is trading around 22p. Make no mistake, this could prove to be a bargain price.
According to the latest investor presentation, forecast profits from the 2.7bn tonne mine are worth $9.8bn in today’s money. This figure could rise to $14.9bn if production capacity is upgraded to 20m tonnes per annum.
In contrast, the group’s current valuation is $4.9bn, including the $3.5bn of stage 2 funding that’s needed to complete the development of the mine.
The shares look cheap at face value, but there are some risks. Today I want to look at three areas which worry me.
1. Running out of cash
The most immediate risk is probably that the company won’t be able to secure the $3.5bn funding package it needs to complete the build of the mine.
Time is now starting to get tight. In September, the firm said that “commitment letters” were expected from lenders in the fourth quarter of 2018. In November, this guidance was extended to “December 2018 and January 2019”. Without this cash, the project can’t be completed.
I expect boss Chris Fraser to find a financing solution. But I suspect that it will cost more than originally expected.
2. An untested market
When a new mine is built, it usually sells into an existing market, such as copper or iron ore. This makes it easier to plan demand and forecast prices.
Sirius is doing something different. Polyhalite is currently only sold in small quantities as a niche product. But Mr Fraser believes that his POLY4 fertiliser can effectively create a new mass-market, displacing some standard potash fertilisers.
The problem is that it’s hard to be sure of this. The only mine selling polyhalite at the moment is the nearby ICL Boulby mine in North Yorkshire. Boulby is targeting polyhalite production of just 1m tonnes in 2020.
In May, ICL’s chief financial officer, Kobi Altman, told a conference “we don’t believe that this will ever be a huge product”.
This could simply be defensive talk. If Sirius is successful, Boulby could lose customers. But there is a real risk here. No one has ever tried to sell large volumes of polyhalite fertiliser.
3. What will buyers pay?
Sirius expects to produce POLY4 for about $30 per tonne by 2024. The firm then expects to sell the product for an average of $145 per tonne, based on customer agreements signed so far.
The potential profits are high. But they’re still a long way off.
Customers who have already signed up may withdraw from purchase agreements, even at the risk of costly legal battles.
Another risk is that the market forecasts on which these agreements are based may be wrong. Bulk customers might only agree to buy at much lower prices, based on their view of the fertiliser’s nutrient value.
Don’t get me wrong
I’m not saying that Sirius Minerals is going to fail. But I don’t think the shares are especially cheap, given the risks involved. For me, this remains a stock to avoid.