Why I'd swap Sirius Minerals plc for turnaround stock Tullow Oil plc in 2018
Today, I'm taking a fresh look at two stocks which have regularly topped private investors' 'most traded' lists in 2017. What's the outlook for 2018?
A success story
North Yorkshire polyhalite mining company Sirius Minerals (LSE: SXX) has made a big impression on the stock market. The group's market cap is now close to £1bn and it entered the FTSE 250 earlier this year after closing a $1.2bn funding deal late in 2016.
Work on the firm's Woodsmith Mine is on time and on budget. And Sirius has already signed up customers to buy between 3.6 million tonnes per annum (mtpa) and 8.1 mtpa of the 10 mtpa production that's targeted for 2024.
Given all of this good news, why do the firm's shares keep falling?
Heading deep underground
Since peaking at 44p in summer 2016, Sirius shares have lost around half their value. At the time of writing, the shares are worth less than they were five years ago.
Some investors believe the shares have been oversold and are now too cheap. I don't agree. Although I think this is a good quality company with great prospects, I think investors are underestimating the risks involved in investing so early.
Polyhalite production isn't expected to start until 2021. The mine isn't expected to reach its initial production target of 10 mtpa until 2024... that's seven more years.
During the long, complex development of a big mine, problems often arise and market conditions may change. There's also an opportunity cost involved in tying up your cash for such a long time.
Institutional investors who took part in last year's $1.2bn fundraising all gained preferential terms. In my view, they are almost guaranteed a profit. Ordinary equity investors don't have this kind of protection, and may not have the 5-10 year timeframe I believe is needed.
In my view, the next opportunity to make money from Sirius will come when the mine is closer to completion. For now, I believe there are more profitable opportunities elsewhere.
To understand how important timing is in the commodity market, you only need to consider oil and gas group Tullow Oil (LSE: TLW). This stock is worth nearly 80% less than it was five years ago, when it was a member of the FTSE 100.
A major downturn in the oil market plus multi-billion dollar spending commitments sent Tullow's fortunes firmly into reverse. The shares fell by about 90% between 2012 and 2016.
The good news is that its outlook is now improving. Spending is falling. And after raising cash through a rights issue and refinancing its loans, Tullow is now benefiting from higher oil prices.
Cash flow is already much stronger and net debt has already fallen from $4.7bn to around $3.7bn. A further reduction is expected when the group publishes its final results in February.
Management guidance is for free cash flow of $0.4bn this year. That puts the stock on an attractive forecast price/free cash flow ratio of 6.6. I expect free cash flow to rise further in 2018. Although this cash will be used to repay debt and not for dividends, I'd expect falling debt to be reflected in a rising share price.
On balance, I rate Tullow as a speculative buy at current levels.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.