Sirius Minerals share price: is it a zero?
Sirius Minerals’ (SXX) share price has been volatile as investors await news on who will provide the £3 billion in financing required for the mining project to progress to the second stage. Where next for the share price?
Published: 15 April 2019
Updated: 18 July 2019
What does Sirius Minerals do?
Sirius Minerals (SXX), a favourite of small investors, is a FTSE 250 company that is currently constructing the UK’s deepest mine. It looks to extract a mineral called polyhalite - a mineral containing potassium - from deep below the North York Moors National Park. It plans to transport the mineral via a 37-kilometre tunnel to a port in Teeside, where it will convert the mineral into fertiliser and then export it across the world.
The project has been running since 2010 but remains in its development phase and is yet to generate a single pound of revenue. Back in 2012, production was projected to start in 2017, but after a series of planning permission and funding issues, Sirius is now expecting to start producing its product, called POLY4, in 2021.
What is the strategy?
Sirius estimates that the size of the global market for its fertiliser could be worth around $245 billion. At full capacity their supply would amount to just 4.5% of this demand and, if priced competitively, could easily be mopped up by a growing market.
As proof of initial demand, Sirius have secured a string of sale agreements, with a number of buyers from various continents agreeing to take up to 8.2 million metric tonnes per annum (mtpa), at 'peak levels'. It is unclear as to how much POLY4 these buyers will purchase before their orders peak.
Sirius believe that the economics of the project stack up and are aiming to become the world’s most profitable fertiliser business. In a previous investor presentation, Sirius estimated that at maximum output the company could operate with an earnings before interest, taxes, depreciation and amortization (EBITDA) margin of between 67-80%, far above the industry average of 25%.
Figure 1: Industry profitability
This sky-high level of profitability will rely firmly on internal estimations of costs not being revised higher. But costs have overrun in the past. In September 2018, capital costs were announced to be $500 million above 2016 expectations. This was due to a decrease in tunnelling advance rates from 25 meters per day to 17 meters per day and the need for a thicker lining of the tunnel.
The average price in the sale agreements is reported to be $145 per tonne, while costs are expected to be around $29.4 per tonne, once production hits 10 million mtpa. This translates into a very attractive operating margin, which could get even better if all goes to plan. Sirius believes it can up production to 20 million mtpa by 2027/28 and reduce costs further.
These lucrative cash flows could last for a long time too, with the life of the mine estimated to be around 100 years.
Where will the cash come from?
But before the company can start generating revenue, which if achieved will come more than a decade after investors first stuck in cash, there is a big issue that the company must first resolve. The company desperately needs a cash injection to survive.
Sirius is expected to run out of cash by the end of June this year and needs to raise $3 billion so that it can continue operations and move into the second stage of its project.
The fundraising plans have undergone a number of revisions over the last 12 months. Most recently Sirius had planned to finance the project through a mix of high-yield bonds, bank debt and obtaining a loan guaranteed by the UK government’s Infrastructure Project Authority.
But this plan was scrapped when the company announced in in early March that they had received a conditional proposal from a major global financial institution who could now potentially be the sole backer for the £3 billion in funding.
Risk to shareholders
Bringing this amount of debt onto the balance sheet isn’t without risk to shareholders. Often overlooked, analysis of a firm’s capital structure is key to understanding the priority of claims that investors have. We’ve written on how you can invest in different parts of the capital structure previously, here.
One risk is that the massive amount of debt leaves shareholders exposed if production falls behind. In a worst-case scenario, there is the possibility that the firm becomes overburdened with debt repayments and has to either liquidate assets or enter bankruptcy. With a higher debt-to-equity ratio, a larger percentage of the proceeds would go to the creditors, potentially leaving shareholders with nothing.
Expect share price volatility
Long-term investors in Sirius Minerals have been on a nail-biting ride since the company first listed on the AIM market in 2005. The charts below shows the drawdown in its share price since 2009, along with the same metric for the FTSE All-Share Index.
Figure 2: Drawdowns: percentage from previous share price high
Since 2009, the share price has fallen more than 50% from its previous peak five times. This illustrates the speculative nature of the stock, which is a widely held by individual investors in the hope that its lottery ticket style attributes could see them win big.
A look at how Sirius Minerals’ share price has performed relative to the FTSE All-Share Index reveals almost identical returns over the last decade, but investors in the miner have taken on a huge amount of risk for no additional compensation.
Figure 3: Risk and return statistics (Dec 2009 – Mar 2019)
|Statistic||Sirius Minerals||FTSE All-Share TR Index|
Source: IG, Bloomberg
Lack of institutional ownership
Analysis of share ownership reveals that 50% of Sirius Minerals is owned by individual investors across a dozen of the UK’s biggest self-directed share dealing platforms. There is also appears to be a distinct lack of institutional support which is more common in quality companies.
The website ShortTracker takes data from the Financial Conduct Authority’s (FCA’s) daily short position report and can be used to see the disclosed short positions in each listed company. Sirius is currently the UK’s 12th most shorted stock and the chart below shows how interest in shorting Sirius shares has risen since the turn of the year. At the time of writing, the percentage of shares sold short is 7.4% of total shares out.
Figure 4: Sirius Minerals shares shorted %
In summary, the company does not yet have a product to sell and has substantial operational and financing risks to overcome before it can start to generate revenue. It must prove that demand for its POLY4 product exists at attractive prices and that operational costs are not hiked so that the impressive margins that are being quoted are realised.
While a high proportion of its ownership are retail investors, there is a growing institutional interest that expect the share price to fall. Bulls should expect continued share price volatility and be conscious that they will not see a regular stream of earnings any time soon – and that’s if everything goes to plan.
What is the latest for Sirius Minerals?
Earlier in July, Sirius updated investors on the development of its mine, financing solutions and new sales agreements. On the call, chief executive officer (CEO) Chris Fraser said 'great progress' had been made but there was 'still more work and improvement that can be done' with regard to safety aspects at the Woodsmith Mine.
The company has reiterated that it is on track to issue a $500 million senior secured bond by the end of September. The issuance of this high yield debt will then open the door to a $2.5 billion revolving credit facility from investment bank Morgan Stanley. This is essentially an overdraft which is often used by firms that experience large cash flows fluctuations and unexpected expenses. Given that Sirius does not yet generate cash, we can assume this credit facility is for the latter.
It is worth noting that both the high yield debt and the credit facility will rank higher in the company’s capital structure than its common equity. This means that risks to shareholders have increased, given that in the event of Sirius defaulting on its debt payments, bondholders and other suppliers of credit will have priority in the return of capital if company assets are liquidated. It is important that investors understand where their investment sits in a firm’s capital structure so that they recognise the potential risks that could lead to a permanent loss of capital.
On a lighter note, Sirius announced additional agreements with two agribusinesses in Europe and India to supply their POLY4 product. Each new deal announced saw the share price jump momentarily, but since first publishing this article in the middle of April, the share price has fallen 20%.
Analysts remain confident that the share price can recover and more, with an average price target of 37.5p, which at current levels implies a 128% upside. Nevertheless, both Liberum and Berenberg have cut their price targets since the start of the year, from 50p and 40p to 40p and 35p, respectively.