It’s been a momentous year for Sirius Minerals (LSE: SXX). After years of planning and working to convince the authorities that the firm’s flagship mining project deserves to get the go-ahead, earlier in the year the final set of approvals were granted and the company has moved quickly to capitalise on this development. Phase one financing has been agreed and barring any construction setbacks, Sirius is now on track to becoming a world-class potash producer.
Unfortunately, even though it has transformed its outlook this year, the market remains wary of the company’s shares. Year-to-date shares in Sirius are up by a third but are still more than 60% below the peak of 48p reached at the end of August.
Rocky road ahead
In some ways, it’s clear why investors aren’t falling over themselves to buy into Sirius. For a start, the company recently raised $900m via equity and loans to help fund the project, which has significantly increased potential dilution for existing shareholders. A £370m placing at a 40% discount to the market price at the time and $450m convertible bond has reduced existing shareholders’ stake in the business, putting downward pressure on the shares.
Still, over the long term it’s likely investors will be rewarded for their dilution.
Long-term prospects
Sirius is an extremely attractive investment to buy and hold. The company was never going to be an immediate success. Mining projects take years just to receive government approval and only then can the construction phase begin, which usually takes longer than expected. According to a survey by consultancy group EY, mining-related capital projects on average run 62% over budget and 50% reported delays. In most cases, it’s shareholders that have to foot the bill for cost overruns so equity dilution was always on the cards.
Nonetheless, the firm’s long-term economics remain intact despite short-term market headwinds. Even after considering the fundraising dilution, and any further dilution as construction gets under way, the potential rewards from the flagship mine more than outweigh the drawbacks.
Based on updated budget forecasts, management estimates the 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 ranging between $1bn and $3bn through variable volume and price outcomes.
As I’ve written before, Potash Corporation of Saskatchewan is one of the world’s largest potash companies by market cap and its shares currently trade at around 11 times TTM EBITDA. Assuming shares in Sirius attract this valuation, and based on current exchange rates, its market cap could exceed £8.8bn at $1bn EBITDA when the company starts producing.
The bottom line
So all in all, even though shares in Sirius have come under pressure during the past few months, the company’s long-term outlook remains attractive. For investors unconcerned about short-term price fluctuations and prepared to wait five years for the company to finish its mine construction, Sirius looks to be a good investment.
