Sirius Minerals (LSE: SXX) seems to be the company everyone loves to hate. 2016 was a momentous year for the company, as the final approvals for its Yorkshire potash mine were granted and management secured Phase one financing. However, it seems investors weren’t that impressed with the company’s progress, and the shares ended the year up a measly 14%, after rising as high as 48.3p at one point.
It’s unclear why the market has failed to re-rate Sirius, although after recent declines it does look as if the company is one of London’s most undervalued and under-appreciated stocks.
Undervalued and under-appreciated
Trying to place an exact value on Sirius today is almost impossible. It will be years before the company’s mine is up and running, and the chances of the project falling behind, running over budget or not yielding the desired results are high.
That being said, while there’s still a lot of risk in Sirius’ shares, the company’s potential upside, even if things don’t go to plan, could be massive. In various scenarios, the company’s shares could be worth multiples of their current value.
Considering Sirius’ current market capitalisation is £770m, the potential uplift possible if the company hits its most optimistic could be as much as 30x.
As I’ve written before, based on updated budget forecasts, Sirius’ management estimates the firm’s potash project now has a net present value of $15.2bn and an internal rate of return of 28% if everything goes to plan. Current estimates show the mine could generate annual earnings before interest, tax, depreciation and amortisation (EBITDA) ranging from$1bn to $3bn, based on variable volume and price outcomes.
Placing a value on growth
Assuming shares in Sirius attract a valuation of 11 times EBITDA (peer average), based on current exchange rates, its market cap could exceed £26.4bn at $3bn EBITDA when the company starts producing. This forecast is clearly very optimistic, so let’s cut it back a bit.
If Sirius hits the $1bn EBITDA watermark, a multiple of 11 times implies a market value of £8.8bn, that’s still 10x more than the company’s current market value. If we’re really pessimistic and assume Sirius completely misses the $1bn target and instead only manages to produce EBITDA of $500m per annum, even this low-ball target implies a market value of £4.4bn when the company gets its mine up and running.
Plenty of upside available
So, even in the most pessimistic scenario Sirius looks undervalued at current levels. One thing to consider is that even if Sirius’ market value only doubles over the next five years, investors will still pocket a return of around 20% per annum, more than three times the market average annual return of 6%.
To put it another way, considering all the risks and the potential upside available here, an investment in Sirius seems extremely likely to beat the market over the next five years.
