Shares in Sirius Minerals (LSE: SXX) fell by as much as 30% this morning, after the firm said that developing the York Potash mine could cost £2.5bn and take five years to complete.
Previous estimates have been for costs of up to £2bn and have projected earlier production dates. However, my impression of today’s Definitive Feasibility Study (DFS) report is that it contains far more good news than bad.
Could be worth $27bn
Today’s DFS will be used to help arrange finance for the build of the York Potash mine. The DFS contains detailed financial projections on cost, expected timescales and potential profits.
Sirius has assumed that the mine will have a 50-year lifespan from when production starts. On this basis, Sirius says that the net present value (NPV) of the project — its future post-tax profits discounted to represent their value in today’s money — is $15bn.
When production starts, Sirius believes the NPV will rise to $27bn. This is because capital expenditure will fall dramatically and cash will start to flow into the business, generating near-term profits.
Sirius hopes that this potential increase in value will attract new investors who are willing to take a stake in the business now for a long-term gain.
Low costs, high profits
Sirius is targeting a production capacity of 20m tonnes per annum (Mtpa), but will initially configure the mine to provide 10Mtpa. That’s partly to reduce costs, and partly because the firm’s current planning permission only covers 13Mtpa of output.
The mine is expected to have cash costs of $33.1/tonne at 10Mtpa and generate cash operating margins of 70% to 85%. When production starts, annual earnings before interest, tax, depreciation and amortisation (EBITDA) of between $1bn and $3bn are expected.
How to pay for it?
Of course, Sirius doesn’t have £2.5bn to spend on the development of the mine. According to the firm, it currently has just £25m in the bank.
Sirius is now working to arrange initial funding of around £1bn to get the project underway. This money will be used to prepare the site, excavate mining shafts and tunnels and fund Sirius operations during the construction phase.
This first round of funding is expected to be a mixture of debt and equity. An equity fundraising could mean a placing of Sirius shares, or the sale of a stake in the project. In either case, Sirius shareholders will see some dilution, but this is the best time for that to happen.
Sirius doesn’t plan for any further dilution after this initial round of funding. The second round, worth around £1.4bn, is expected to be provided by debt investors.
Are the shares a buy?
Sirius currently has a market cap of £444m. My guess is that an equity investment of up to £500m is possible, although it could be much less.
At this point, we don’t know what valuation will be used for the equity element of the firm’s funding. However, today’s DFS suggests to me that buying Sirius shares at less than 20p could be a good long-term buy.
There are still some risks, but this appears to be a high-quality project with a decent chance of success.
However, big mining projects are prone to cost and time overruns.
