Whenever I have covered Sirius Minerals (LSE: SXX) in the past, I have always tried to make it clear that this is a high risk, high reward opportunity. And even though the company has recently sealed the deal for the second phase of funding for its flagship North Yorkshire potash mine, I continue to believe that this is the case.
In the worst case scenario, the equity value of the company could be nothing, but on the other hand, if everything goes to plan over the next 10 years, Sirius could be worth significantly more than it is right now, and today I’m going to explain why I believe the enterprise could eventually command a multi-billion dollar valuation.
Building a business
Sirius believes that the economics of its potash project could help it become the world’s most profitable fertiliser business. A historic investor presentation from the company suggests that at maximum output, the enterprise will be operating with an earnings before interest, taxes, depreciation and amortisation (EBITDA) margin of between 67% and 80% above the industry average of 25%.
The good news is, the company has already inked agreements with potential buyers agreeing to take up to 8.2m metric tonnes per annum (mtpa) of its polyhalite production. The average sale price on these agreements is reported as being $145 per tonne, while management is predicting production costs of around $29.40 per tonne when production hits 10m mtpa.
For the sake of this article, and to give a margin of safety, based on these numbers I’m going to assume that the company can generate an operating profit margin of $100 per tonne when production hits this level, which gives a rough operating profit of $1bn per annum.
This target assumes that the company meets its cost forecast and doesn’t encounter any problems along the way. Considering the fact that the group has already increased its capital costs by $500m in the past 12 months, I think it is highly probable that the final production cost figure will come in higher than initial estimates.
Still, the firm wants to increase output up to the 20m mpta level by the late 2020s, which, management believes, will lead to further cost efficiencies. Overall, management’s own numbers suggest that the company could generate $1bn to $3.3bn in EBITDA at full production, which at an EBITDA margin of nearly 80% would make the business the second most profitable potash producer in the world.
Number crunching
Because there are so many variables to consider with this number, I think it’s probably better to try and place a value on Sirius using revenue projections instead.
On this basis, assuming the company can reach production of 10m mpta, at an average price of $145 per tonne, we get total possible revenues of $1.5bn. At the time of writing, BHP, the world’s largest mining group, is dealing at 2.8 times sales. Using the same valuation for Sirius gives a possible market cap of $4.2bn or £3.3bn at current exchange rates.
Following the recent fundraising, the company currently has just under 7bn shares in issue so, on a per share basis, the stock could be worth as much as 47p, a gain of 210% from current levels. That’s why I believe the Sirius Mineral share price could be worth 47p, although I should make it clear that these are only rough figures.
