Putting Up Your Box

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"The would-be UK fertiliser miner, Sirius Minerals, released first-half results Thursday. One of those accounting phrases we were always taught to take seriously jumped out, an “emphasis of matter” from the auditors (with our, er, emphasis):

Without modifying our conclusion on the interim financial statements, we have considered the adequacy of the disclosure made in note 1 to the interim financial statements concerning the Group's ability to continue as a going concern. The Group is involved in efforts to complete the stage 2 financing to secure long-term project finance for the North Yorkshire Polyhalite Project, the timing and outcome of which is uncertain. These conditions indicate the existence of material uncertainties which may cast significant doubt about the Group's ability to continue as a going concern. The Group financial statements do not include the adjustments that would result if the Group were unable to continue as a going concern.  It is no surprise the ongoing viability of the project hangs on a $3bn+ financing package. If the company can't get lenders on board, there will be no mine.

Accountants deal in judgments of materiality, however, and that phrase “material uncertainty” hasn't appeared in the Sirius accounts since the 2016 interim results.

According to international standard on auditing 706, in the International Federation of Accountants handbook, an emphasis of matter disclosure should be made when it is necessary to:

(a) Draw users’ attention to a matter or matters presented or disclosed in the financial statements that are of such importance that they are fundamental to users’ understanding of the financial statements; or
(b) Draw users’ attention to any matter or matters other than those presented or disclosed in the financial statements that are relevant to users’ understanding of the audit, the auditor’s responsibilities or the auditor’s report. 

Here's part of the going concern report in note 1 of the Sirius statement, referred to above, with our emphasis:

On 6 September 2018 the Group announced an updated estimate of US$3.4bn to US$3.6bn for the capital funding that would be required to complete development of the Project to a 10 Mtpa production capacity. Subject to the successful completion of due diligence and a satisfactory financing plan being presented by the Group, the Group expects to secure credit approved commitment letters from lenders in the fourth quarter of 2018 and to achieve financial close of stage 2 financing in the first quarter of 2019. The Group is seeking up to a US$3bn senior debt financing and is working towards securing further additional necessary financing of US$0.4bnto US$0.6bn through the most efficient and cost-effective capital structure.

The Board of Directors continues to believe that the stage 2 financing will be successfully completed, however there is a risk that a successful outcome may not be reachedThis therefore represents a material uncertainty that may cast significant doubt upon the Group's ability to continue as a going concern. 

The Group's latest cash flow forecasts indicate that it currently has sufficient liquidity to continue development of the Project on its current schedule into Q2 2019 when the proceeds of stage 2 financing will be required. Should the Group wish to continue to operate into late 2019 or early 2020 without the stage 2 financing proceeds, they would need to curtail discretionary expenditures from Q1 2019 until further financing was secured and thus could continue to operate for a period of at least 12 months subsequent to the date of the approval of these financial statements. 

Having assessed the principal risks and having regard for the above, based on the current likelihood of the success of the stage 2 financing and the technical completion of construction of the Project, the Directors consider it appropriate to continue to adopt the going concern basis of accounting in preparing these consolidated financial statements. Therefore, these interim financial statements do not include any adjustments that would result if the going concern basis of preparation was inappropriate.

There has always been the chance that the project is not viable, but after stage 1 financing was secured in November 2016, the material threat to Sirius as a going concern went away.

Now it is back. It comes after the group announced this month its estimates for the fertiliser mine's cost had risen, by about £0.5bn. The additional capital will have to be financed by fresh equity or subordinated debt, on top of the $3bn of senior debt it must raise, and a key unknown is the size of the contingency lenders insist must be funded, over and above that £0.5bn estimate, in case costs go up again.

Some might also wonder what level of “material uncertainty” is assumed by investors, given the group's £1.4bn market capitalisation."



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FT: Back Ground Noise

"Interviews with three of the Chinese partners announced by Sirius Minerals, the UK group attempting to dig a fertiliser mine in North Yorkshire, illustrate the gap between the scale of their businesses and the commitments made so that Sirius can secure $3bn in financing for the controversial project.

Sirius has unveiled a string of such deals with foreign customers this year, essential steps to demonstrate a viable market for its novel product, polyhalite, as it negotiates with lenders and seeks a $1.5bn UK government guarantee to underpin the project.

Sirius has described its two newest Chinese partners as small, entrepreneurial businesses. While their enthusiasm for the product is clear, so is the transformation required for them to distribute around $300m worth of fertiliser a year in the 2020s.

Guangzhou Eiliseng Biotech Co has agreed to buy at least 1.15m tonnes in year seven of the UK mine's production, which will be 2028 on current schedules, at a cost of around $165m based on the miner's indications for typical pricing. Sirius Minerals recently hosted a trip to its potash project for the customer, and we caught up with Jing Hai Shan, Eiliseng's youthful general manager, to find a bit more.

First the background. Eiliseng was founded in 2014. It has 400 staff and its “speciality areas” include Inner Mongolia, Hebei, Sichuan, and Yunnan. The company handles between 600,000 and 630,000 tonnes of seeds and fertilisers a year, selling mainly to distributors and wholesalers.

So the deal with Sirius is a serious undertaking for the company, a point acknowledged by Jing. But as China tries to avoid further contamination of its farmland, he says demand for Poly4, as the product is known, will take off.

“In a nutshell it’s because of change in government policy. Beijing is pushing towards a zero chemical fertiliser use by 2020. Poly4 fits into this perfectly. It’s organic,” Jing explained during the meeting at Sirius' London offices.

“So we are going to see a decline in chemical fertiliser usage and an increase in organic usage which is why we are daring to sign this contract. In terms of distribution I don’t see many issues selling this product,” he added.

(A change in policy is coming, but it overstates the impact to suggest a ban. The plan is for a zero increase in chemical fertiliser use from 2020.)

There are other attractions, including a shift in diet, according to Jing: “a lot of China’s arable land is damaged and we think Poly4 can help fix damaged land to a certain extent while providing fertilisers for the growth of plants. We see a huge market for this product,” he said.

“In 2015 the Chinese government came up with a new policy to make potatoes a main strategic crop because it’s healthy and it can be stored for longer. The government has put out a lot of new directives as well as providing subsidies to potato growers,” said Jing, who continued: “I see a bright future for Poly4.”

The other Chinese customer announced this year is the Yantai Service Agricultural Science and Technology Co. According to SAIC filings, it was incorporated in June last year. We reached company general manager, Zhang Yabin, by phone. He confirmed that the company signed a deal with Sirius at the end of July. 

Zhang said, “the fertiliser it's organic, good for the environment and it can improve the soil. These all fit in the national policy. So we are confident about the products.” However, Zhang admitted that the Chinese company has not locked in any potential buyers yet.

He declined to discuss details of the contract, but said: “we expect to see a small volume of polyhalite coming to us at the end of this year or the beginning of next year.” The mine is not scheduled to go into production until 2021, but Sirius said all customers receive small amounts of product to test on crops.

Yantai is a trading company, according to Zhang, which will not process the products imported from Britain, and instead will directly sell them to customers in China. Sirius said the entity has committed to buy 0.8m tonnes in the sixth year of production.

Sirius has a history of signing deals with optimistic Chinese customers which have not stood the test of time. In 2013 it announced a deal with Yunnan TCT Yong-Zhe Company Limited for as much as 1m tonnes of Poly4 a year, but cancelled that arrangement three years later.

TCT was replaced in 2016 by Yunnan Dian Huang Peony Industrial Group, described by Sirius as “a national peony seed oil production enterprise in China with strong government support and backing.”

Later that year we spoke to Dian Huang CEO Wang Xiaotian. He said it was a joint stock company in which 40 per cent was held by a Yunnan local government. He said the company had contracted with 1,000 rural co-operatives to grow walnuts and peonies on 2,000 sq km in Yunnan, and had ambitions to expand to 3,000 rural co-operatives.

Of the Sirius deal, he said “their mine will make fertiliser. We will be their biggest customer”, distributing in Yunnan, Guizhou and Sichuan.

Last year the company lost a local court case related to an unpaid bill for seedlings of around $35,000. In July, Sirus said it and Dian Huang had “mutually agreed to terminate the existing agreement for supply of up to 1 Mtpa”.

A spokesperson said, “as Sirius is providing a disruptive product its strategy includes partnering with disruptive businesses to gain market share.” Chinese companies represent 2.5m of the 8.2m tonnes in peak annual volumes the company has said it is contracted to supply.

Related links:
Sirius Minerals buys its way into Brazil — FT Alphaville
Sirius gets $250m cash boost from Australia’s richest woman — FT
Costs up and cash needed at Sirius Minerals — FT Alphaville
Sirius Minerals: money for a hole in the ground — FT Alphaville
Sirius Minerals and the battle to build Britain’s deepest mine — FT"