2 things we can learn from Sirius Minerals

Michael Taylor shows two lessons we can learn from Sirius Minerals.

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The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

The recent offer from Anglo American plc for Sirius Minerals (LSE: SXX) stock at 5.5p has left many a private investor out of pocket. Understandably, many Sirius investors feel that they have been sold down the river by a board that made many promises and ultimately failed to deliver.

While the price was a hefty premium to the close before the offer was announced, Sirius Minerals’ stock had been trading at prices well above 30p. However, while there is little private investors can do right now, they can certainly educate themselves for the future.

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Mining projects require capital expenditure

Many private investors are attracted to mining projects because of the stable cashflows that they can deliver. Minerals and metals are used in many industries, and once in production a mine can last decades. That was certainly the plan for Sirius Minerals’ mine.

However, getting the resource out of the ground requires both time and money. Completing the necessary feasibility studies and resource estimates in order to see whether the mine is economic or not requires investors to stump up cash, and more cash is needed to build the infrastructure required so the resource can be dug out of the ground.

Looking at the capital expenditure requirements for a project can help investors decide how risky the project is, given the equity value. When the bonds failed for Sirius Minerals, the company required over $2.5bn in funding – a figure that was in excess of multiples of the market capitalisation of the stock.

Check the management’s shareholdings and salaries

When backing a management team, it’s important to know about the individuals running the project. Have they done this before? Have they created value for shareholders in the past?

Are they technically qualified for the job? Find out about their past employment, and use the company’s annual report to check how much management are paying themselves and how many shares they own.

The goal here is to see if management are running the company for the benefit of themselves or for the benefit of shareholders. This is subjective, but when I see a chief executive paying themselves way above the market rate and owning zero stock, I assume that they are running the business as a lifestyle vehicle.

Nil-cost options do not count. Management will make the argument that they are ‘necessary’ in order to retain key members of staff, but usually this means they have their snouts in the trough and are transferring shareholder cash from the company to their wallets.

Unfortunately, in the case of Sirius Minerals, management paid themselves very well and awarded themselves plenty of options that they did not pay for. This is why I warned against investing in the company back in November. It’s also why I recommend that any investors interesting in mining shares look at both capex required and the management team in detail.

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Michael Taylor does not hold a position in Sirius Minerals. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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