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Is Sirius Minerals a bargain buy or a value trap?

The Sirius Minerals (LSE: SXX) share price went into freefall on news that it pulled its $500m bond sale at the beginning of August, with the price falling over 30% in the month to date. The company blamed ‘current market conditions’ for the suspension.

The bond sale was crucial in allowing the company to access a $2.5billion facility agreed by JP Morgan, and finance the construction of a polyhalite mine in the North Yorkshire Moors.

Mining companies are inherently risky for investors. Typically, it takes some time before the mining company reaches peak levels of output and cash flow stabilises. Production is expected to start at the Woodsmith mine in 2021 and will ramp up to 10 million tonnes per annum in 2024, with the hope to double output to 20 million tonnes per annum in 2029.

Sirius Minerals has confirmed that it has secured peak supply agreement aggregate volume of 11.7 million tonnes per annum of POLY4 in Europe, Southeast Asia, China, Africa, North America and South America.

This all sounds promising. However, this makes expected cash flows incredibly difficult for investors and lenders to visualise, as the sales agreements are for when the Woodsmith Mine is running at peak supply. 10 years is an incredibly long timeframe to assess future cash flows, especially when production has not yet started.

Value investors may see the recent plummet of the share price as a buying opportunity. However, they should be cautious about buying a part of the business at the moment. For a start, POLY4 has been through some degree of testing, but it is not commercially proven. 

In addition to this, it is crunch time financially for the company, as chief executive Chris Fraser has insisted the business will be able to sell the bond after the US-China trade tensions ease, next month. This will do little to reassure investors. If Sirius Minerals fails to sell the bond and US-China trade tensions fail to progress, what will happen? JP Morgan may lose interest and decide to pull the funding, putting the whole project at risk.

Being the world’s largest mine for polyhalite, the project at Woodsmith Mine was always going to swallow up large amounts of capital. For a company not yet generating cash flows, funding is critical for Sirius Minerals. 

Buying shares today in Sirius Minerals is a massive risk. The uncertainty surrounding the project’s funding concerns me, as does the timeframe for when the output is at full swing and the business starts generating cash.

If the golden rule of value investing is to not lose money, a true value investor would probably pass Sirius Minerals off as a value trap and not a bargain buy. For me, it’s one to avoid for now.

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T Sligo has no position in any of the shares mentioned. 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.