Sirius Minerals (LSE: SXX) is one of the market’s most misunderstood stocks. The company has a bright future, but it seems the market is wary of the shares thanks to the level of risk involved with early stage mining companies.
With this being the case, for long-term investors, the company looks severely undervalued.
Timing is key
If Sirius can get its North Yorkshire potash project up and running, on time and on budget, the shares could be worth many multiples of their current price. However, this is a big if. The majority of mining projects fail to get off the ground, or collapse due to cost overruns and poor planning. As of yet, there’s little evidence to suggest that Sirius won’t fold as the challenges mount for the company, as so many of its peers have done before.
But over the next 12 months, the outlook for Sirius could change significantly.
It is set to start the construction of its mine this year, which is always a groundbreaking moment for any mining company. As so many early stage miners fail to get past the planning stages, Sirius is already bucking the trend.
When construction finally gets under way (highways construction has already begun and should be complete by mid-April), Sirius should be able to get some idea of how accurate its initial budgets and time forecasts are. If the company quickly realises it was too conservative in its original projections, the market could quickly re-rate the shares higher. On the other hand, if Sirius reveals its figures were too optimistic, the shares could head the other way.
There’s always a tendency with miners to underestimate how much a project will cost due to pricing/fundraising constraints. By lowering estimated construction costs, project returns improve, increasing the allure for investors. Once the first round of investment funds have been secured, there’s more room for flexibility as the initial investors will be more willing to support a project that’s over budget than write off the investment.
Proving the market wrong
I believe the market is betting that Sirius has adopted the above approach, and until the company can prove otherwise, the shares will remain depressed.
However, if Sirius can show it has not put out artificially low figures, the shares could rally back up to 40p, the level they were when the company’s flagship project was initially approved by planning authorities.
How long will it be before this is the case? Well, management is planning to start site preparation at the mine site during the second quarter, in preparation for shaft sinking later this year.
Preparation will include site clearance, construction of the shaft sinking platform and construction of site offices. If this first stage goes off without a hitch and then the shaft sinking later in the year goes to plan, the market should quickly regain confidence in the business.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.