Investors betting that the Sirius Minerals (LSE: SXX) share price will fall have increased the size of their short positions to 5.64%, up from 4.49% one month ago.
This may seem surprising. After all, Sirius shares have already fallen by more than 50% over the last year. During the same period, the company has secured a $3.8bn financing package that’s expected to fund the mine through to completion.
With this key risk eliminated, why are investors are still bearish about the stock? I’ve been taking a fresh look to see if it’s finally time to turn positive on Sirius.
The $500m question
The next hurdle that Sirius chief executive Chris Fraser must clear is to raise $500m from bond investors. This is needed before Sirius can gain access to the $2.5bn funding facility it’s agreed with US bank JPMorgan.
Sirius will be pitching the bond to potential investors in August. The firm must complete the deal by the end of September, or it could run short of cash.
I’m confident that Sirius will find buyers for this bond. But based on its ‘B’ credit rating and previous borrowing costs, I expect the firm to pay 10%-12% per year for this cash. Since the bond is for eight years, that could mean interest costs of $400m to borrow $500m. That’s expensive money.
It’s worth it
This won’t be the end of the borrowing either. The $2.5bn facility provided by JPMorgan is intended to be gradually refinanced with future bond issues. If the project goes well and remains on schedule, these may be shorter and cheaper. But the cost will still be significant.
However, if we take the long view, these expensive loans probably won’t matter. If the mine is successful, it will be one of the most profitable in the world. Based on Sirius’s forecast for the project, the Woodsmith mine should comfortably generate enough cash to repay all the planned debt.
Risks vs reward
All investments carry risk and potential reward. The secret to making big money from stocks is to find opportunities where the balance of risk and reward is attractive.
What’s hard about SXX stock is that the company faces so many uncertainties, spread over a long period of time. Production isn’t expected to start until 2021 and won’t reach initial capacity of 10m tonnes until 2024.
We’ve already seen cost overruns on tunnelling work. Other parts of the project may yet go over budget or be delayed.
There’s also market risk — will the market for Poly4 be as strong as expected, and what price will it fetch when supplies start to flow? Although Sirius has lined up a number of big buyers, this is essentially a new product.
What price would I pay?
The firm’s own projections give the project a net present value of 68p. This represents the value today of future cash profits. At 15p, the share price should provide an attractive margin of safety.
If I wanted to invest in Sirius, I’d consider buying some at this level. But I’d only do this with money I could afford to lose and wouldn’t need for at least five years.
Mr Fraser is slowly making progress towards de-risking the project. But Sirius remains a high-risk speculative buy only, in my view.