Interactive Investor

Why Sirius Minerals project is worth $3.9bn

25th October 2016 16:02

Lee Wild from interactive investor

Sirius Minerals shares traded above 37p for the first time in almost a month on Tuesday after the potash miner agreed a royalty deal with a subsidiary of Hancock Prospecting Group, run by Australian billionaire Gina Rinehart. But what does the house broker think?

WH Ireland analyst Paul Smith repeated his 'buy' rating and 60p price target. Richard Knights at Liberum agrees with the rating, although he sticks with a more modest 50p target for now.

"The deal is a clear endorsement of the project from a major Australian mining and agricultural business, reduces the required Phase One financing to $800 million (£661 million) and is significantly less dilutive than straight equity," explains Knights.

"Applying our $125 per tonne (/t) polyhalite price and ramp up assumptions, the deal implies a project valuation of $3.9 billion vs. its $930 million market cap, with valuation dilution equivalent to equity raised at 95p. We await details of the remaining pieces of the $1.1 billion phase one funding."

News on that Phase One financing should come shortly, given existing guidance targeting "end of summer".

To get to his project valuation of $3.9 billion, Knights takes the average royalty rate of c.4% and applies his average expected margin (at a $125/t polyhalite price) of 73.5%, implying 2.9% of cash flows go to Hancock, which invests heavily in farmland.

"Paying $250 million for 2.9% of cash flows implies a valuation of $8.5 billion for the pure cash flow stream," adds Knights. "Less 15% effective tax (on earnings before interest, tax, depreciation and amortisation [EBITDA]) and subtracting capital expenditure [net present value] of $3.3 billion delivers a c.$3.9 billion implied valuation for the project as a whole.

"Whilst a royalty is materially lower risk than equity, particularly given the delayed instalment, the outcome for existing equity holders is equivalent (on our assumptions) to Hancock purchasing equity at 95p."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Related Categories