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Sirius Minerals (LSE:SXX) is one of those stocks that looks to have a golden future ahead with its thematic fertiliser play – a market with growth reliant on the dietary shift in emerging economies to increased meat consumption as income per capita rises – which looks set to be one of the solid investment trends of the next few decades.
It has the largest potash mine in the world in its Yorkshire prospect, where only 2% of the project area has yielded 1.35 billion metric tonnes of inferred resources – although this is the tip of the iceberg with a 3.3-6bn tonne JORC target for the full prospect. However, the project is controversial as it lies next to the North York Moors National Park leading to calls from Greens and Nimbys to put a stop to future development plans. On Monday the Company revealed its design for the mine, playing an optimisation game between costs, appeasement of conservationists, and probability of government approval.
Market Background
Fertilisers are one of the guns in the armoury for farmers to boost their crop yield, alongside herbicides, pesticides and genetic modification, such as Syngenta’s Vipterra trait triple stack corn. The results of crop science can be seen in American corn yields where 1.5% growth per year since the 70’s has increased bushels per acre from 80 to 140. Emerging markets are gradually adopting the more advanced methods as inflation and tighter food supplies are beginning to bite.
At present, fertiliser accounts for about 10-15% of farming costs in developed nations, and comes in three main forms: nitrogen (Urea), phosphorus (DAP) and potassium (Potash) based compounds.
Potash is sold to farmers in two types and depending on the potassium oxide content – MOP (muriate of potash) and SOP (sulphate of potash), although it can be combined into a package with other nutrients. The potash market is roughly 50-60 million tonnes per year with 70% MOP, 3% SOP and 30% compounds.
However the use of SOP over MOP is preferred, as the presence of chlorine in MOP can lead to fertiliser burn due to osmotic stress (basically too much salt dries the plant out). Furthermore SOP also provides Sulphur, an important plant growth nutrient lacking in some soils, but ultimately SOP is used for fruits, vegetables and other higher value crops. As such, SOP commands a premium to MOP in the market, which has historically been at the 50% mark, although at present sits around 20%.
The international potash market is held to ransom by a concentrated reserves base and cabal of companies controlling supply. Canada, Russia, Belarus and Germany control 80% of reserves and production, with the companies Uralkali, Beruskali, Potashcorp, Agrium, K+S, Mosaic and ICL controlling c.70% of reserves and production.
There are two oligopolistic export associations – Canpotex (Potashcorp, Agrium and Mosaic) and Belorussian Potash Corporation (Uralkali and Belaruskali). These are the price setters in to emerging markets with K+S and ICL dominating the European price due to their proximity.
Most mines are from dried sea beds 100-1000m underground, however the Israeli and Jordanian Companies, ICL, and Arab Potash Corp, simply dry out their respective halves of the Dead Sea then scoop it up, leading to lower capex costs and higher gross margins.
Sirius (LSE:SXX)
The Company has a set of hurdles and potential catalysts for a re-rating ahead of it.
- A full definition of the resources, potentially this year (not the 2% looked at so far, or essentially pushing the Jan ’11 JORC figure into inferred resources, and some of the June ’12 inferred resources into reserves).
- Secondly the financing of £1.7bn to build the first stage of the mine with planned production of 5 mtpa of ore in 2018 – or 1.4mtpa of SOP leading to revenues of $700m assuming a conservative price of $500 per tonne, or a 10% market share
- Lastly but most importantly, government approval, set for early 2013.
The Company plans to expand production to a 15 mtpa from 2018, using the cashflow from phase 1, pushing into a positive free cash flow situation by 2021. Part of the plan is to use the by-products of gypsum and epsomite to supplement the revenue streams of the core business leading to a low cost OPEX potential of $65/t of SOP. Alongside, the Company plans to pump the product 30 miles to a Teeside processing plant.
So far the Company (LSE:SXX) looks like they have done a good job of appeasement, waving its funky green illustrations off to the press in a pre-submission public consultation process. The mine is to be fully submerged under an artificial hill occupying 4.5ha of 100ha site, with farmers receiving annual payouts to the tune of £45m, and a local community fund to boot. The argument of jobs, exports and a considered development plan seems to be outweighing the negatives from the usual crowd.
On the financing front, the Chief Executive, Chris Fraser, says he expects to use a combination of both equity financing and debt in bonds or bank loans – leaving the question to what level of dilution will take place.
It has to be noted that the Company could be a takeover target due to the hegemonic industry structure, and valuing it in this manner offers significant upside to the present share price. Comparables are the Potash One bid by K+S and BHP’s Athabasca acquisition in 2010. These give a rough estimate of $1.5/t of SOP indicated and inferred resource. With a conservative JORC assumption of 3.5 billion tonnes of resources or 800 tonnes of SOP (23% concentration in ore body), an enterprise value can be estimated at $1.2bn compared to a present market cap of $400 (bearing in mind prices are higher now than at the comparable deal periods, the JORC figure is at the lower end of the estimate and is an exploration target, not yet a booked inferred resource).
This is all reliant on the government giving the go ahead, but you can see the way the cogs are whirring in Whitehall with the promise of 1000 jobs and more to come – It would be pretty foolish for the UK to miss out on taking a top spot in a growth industry, and considering the connections at the Board level, notably Baron Hutton of Furness, the Company has inroads to whip things along. The world class asset of premium fertiliser looks undervalued considering past m&a activity, the tight and growing end market, and the highly probable approval (IMHO), however the risks are the degree of dilution and the long wait until the cash comes flooding through the door. On balance it looks like a buy, hold and hope for a takeover, although it might be prudent to wait for the recent media storm to die down and a better entry point.
I compliment Charlie Hayter on this article. As a Sirius Minerals investor and long-time student of the potash market, I know how rare it is to find an accurate, well-researched and well-written summary of the sector. Most analysts leave me frustrated. Journalists never do their research. But Charlie Hayter, who I have never previously heard of but will become well-known, gets deep under the skin of his subject and processes his research most intelligently to arrive at his conclusions. I would buy shares in him if he were listed.
I have nothing to add about Sirius Minerals, except that its blue chip management team has the knowledge and ability to take it all the way to production; and judging by their meticulous attention to detail, they expect to resist all overtures. I will probably be dead by the time they produce potash but my will includes a codicil which prevents my heirs from selling my Sirius shares before 2025.
Sirius Minerals tumbling 3¾ to 25p. Dealers were flustered by the departure of director Alan Watling
Sirius Minerals – Potash vs. Phosphate: What’s the Difference?
14th Feb
http://www.directorstalk.com/?s=Sirius+Minerals