Yorkshire potash miner Sirius Minerals (LSE: SXX) has been a standout performer this year, climbing by 170% since January. A successful round of planning applications has left the company poised to start construction as soon as financing is confirmed.
Despite this, Sirius stock has fallen by 25% over the last couple of weeks and is well down from its all-time high of 52p. Are the shares simply settling down after a rapid climb, or is a bigger pullback now likely?
Why are the shares down?
There’s no doubt that Sirius is sitting on a large and valuable asset. The company’s figures suggest that the mine has a discounted net present value (NPV10) of $15,238m, rising to $30,023m when commercial production starts. These numbers show the value in today’s money of future profits expected from the mine.
Given that Sirius currently has a market cap of just £908m ($1,200m), you might think the shares would be a screaming buy. But there are two risks investors need to consider.
Even if everything goes smoothly, commercial production isn’t expected to start until 2021. Production is then expected to continue for many decades. Shareholders will need to take a long-term view. Anyone buying today needs to buy at a big discount to NPV, in order to have a chance of making a decent profit over such a long period.
The second risk is that the $15,238m NPV is based on Sirius arranging stage one financing of $1.09bn. So far, that hasn’t happened. I’m fairly confident Sirius will raise the cash, but the terms of the financing could have a big effect on the value of existing shares.
This first round of financing is expected to be a mixture of debt and equity. We don’t yet know how large the equity component will be, but there’s a risk that existing shareholders will face significant dilution.
For example, if stage one investors demand a 50:50 split, then Sirius would have to issue more than £400m of new shares. This would give the new investors nearly a third of the company, reducing the equity value of existing shares by about two thirds.
What happens next?
Sirius boss Chris Fraser is working hard to secure stage one financing for the project. But an update last week focused on stage two financing and didn’t include any new information about stage one.
Given that we’re already in September, plans for construction to start in 2016 are beginning to look ambitious.
Institutional investors who are willing to accept the long-term risk of financing a major new mine can afford to drive a hard bargain. I’d expect them to be very thorough in their due diligence. Delaying the start of the project by a few months is irrelevant if you’re investing on a five-to-10-year timescale.
Wait for a rainy day
This is a complex and long-term project. I suspect there will be a few hitches and delays along the way. Market conditions for potash producers are also likely to change while the mine is being built.
I wouldn’t buy Sirius stock today. In my view it’s very likely that Sirius will fall out of favour with investors at some point over the next few years. I think that will be the most profitable time to buy.
