Graphite miner Syrah Resources Ltd (ASX: SYR) is a favoured target of short-sellers at the moment, regularly featuring in our weekly most-shorted stocks as well as in the financial media.
Short sellers Viceroy, also known for shorting Quintis Ltd (ASX: QIN), have released a detailed manifesto of how they believe Syrah is overvalued and heading for a heavy fall. Their assertions are:
- Syrah's graphite mine will be the largest in the world and will upset the supply-demand balance, leading to graphite prices being greatly below those forecast by Syrah
- Syrah's Balama mine is likely to be more costly than indicated based on poor road infrastructure and long distance to port, among other issues
- Syrah and the market are overestimating the likely profits to come from the company's projects and, as a result, the company is not worth more than $0.70
On the other hand, new managing director Shaun Verner has asserted that graphite demand is expected to grow, believing the company will achieve significant economies of scale (and thus have a lower production price) and become the world-leading supplier of graphite.
Rather than weigh into this debate, about which I am underinformed compared to either Syrah or Viceroy, I want to present an alternate perspective – that of the shareholder.
Shareholders need to ask themselves, 'given the risks and potential rewards of everything I know about Syrah, Viceroy's allegations, and the global graphite industry, am I confident that over the next 5 to 10 years I will be rewarded for my tenacity in continuing to hold shares in Syrah?'
What's a mine worth?
If you are a long-term shareholder, then the current share price of Syrah is almost irrelevant. To fixate on the past, e.g., 'shares were $6 in 2016' would be a grave mistake. The company's ability to mine and potentially enrich graphite and generate adequate levels of profit are what will spell success or failure from an investment perspective.
One way to look at it would be to imagine that Syrah is currently only 'worth' A$400 million, or around $1.50 per share based on the value of its net assets, according to its annual report to December 31. Then subtract a portion of that, as not all of the value of the 'Mine properties and development' would be realisable in the event of a fire sale.
So shares only have, just say, $1 of tangible assets per share underpinning their value. Shareholders must decide how much extra per share on top of that they would be willing to pay for a share of the future profits (whatever they may be) of Syrah's graphite mine. To know how much you would be willing to pay, you have to know how much you are likely to earn!
With the publication of Viceroy's research (which can be found via Google), investors now have two alternative future scenarios to compare. You can work through each party's assumptions step by step, see what challenges there are and see whether one side's claims seem more reasonable. You can also compare with peer earnings to see what Syrah would have to earn to justify a certain share price.
Compare with peers
Mega-miner BHP Billiton Limited (ASX: BHP) is a poor comparison for Syrah, but purely by way of illustration we could discover that BHP earned $12.3 billion in underlying earnings before interest, tax, depreciation and amortisation (EBITDA) in 2016. Today's market capitalisation is $124 billion, pricing BHP at about 10x EBITDA.
Thus we could say that Syrah would need to earn $70 million in EBITDA to justify today's market capitalisation of $711 million. Or maybe Syrah is a way more promising company than BHP, should be priced at 20x EBITDA, and thus only needs to earn $35 million. There are other elements such as debt, taxes, likely growth and so on to consider, but you can use that type of comparison as a yardstick to see whether Syrah's (or Viceroy's) assumptions could see Syrah generate the kind of money that would justify a certain valuation.
The bottom line
Never forget that both Viceroy and Syrah are strongly financially motivated to convince you that their side of the story is correct.
And if you're at the bottom of this article and thinking that the above sounds like a lot of hard work with many uncertainties, well, you'd be right. If you're not in a position to put in the hard yards and come to a well-founded decision about the Syrah's likely future, you might want to think about selling your Syrah shares. After all, in that situation, you literally don't know what you have invested your money in. And if you're a would-be buyer of Syrah, well, you can always choose to tune in later – Balama's got an estimated 60-year mine life, it's not going anywhere.
