On April 28th /08 RBC Capital Markets analysts Adam Schatzker and H. Fraser Phillips wrote up a report entitled “Finding Value in the Uranium Equities.”
Takeaways From The Report
Commenting on the dramatic decline in the spot price of Uranium and Uranium equities in the last year, Schatzker and Phillips write “From the highs in June 2007 to the lows of April 2008, we have seen both the uranium price and the equities fall by approximately 41% and 52%, respectively.” Schatzker and Phillips believe that the depreciation in the spot price of Uranium recently has been a result of 2 reasons: 1) Intensive selling pressure, especially from a trader; and 2) Lack of necessity buying in the spot market (82% of Q1/08 spot purchasing was discretionary, according to Ux Consulting). Overall, they think that “The buying in Q1/08 was considered to be evenly split between traders, producers, utilities and speculators.”
So how relevant is the current spot price of Uranium to valuations of equities in the Uranium sector?
Schatzker and Phillips begin by dividing uranium producers into 2 groups:
1) Large, existing producers such as Cameco, Rio Tinto, BHP Billiton and AREVA that are publicly-traded; and
2) New producers such as Uranium One and Paladin Energy.
They then go on to write “The existing contract baskets and future contracts (to be established) are very different for these two groups.” For example, according the “recent filings, Cameco has sold about 60% of its future production under contracts that will reference future spot and long-term pricing; the other 40% is sold at base-escalated prices with inflation factors. Therefore, Cameco's exposure to the future spot price is limited to perhaps 30% of its volumes.” On the other hand, “Uranium One has sold most of its contracts using market-related terms that will reference the spot price at the time of delivery. In addition, the company has more uranium uncommitted to contracts than uncommitted material. Therefore, depending on how it establishes its future contacts, Uranium One may have substantial exposure to the future spot price. However, we expect that future contracts will likely have some component of fixed economics and perhaps some contracts will reference the long-term price in addition to the spot price. Other producers, such as Paladin Energy, are in a position similar to Uranium One while companies in earlier stages of development such as Aurora Energy Resources, Uranium Energy Corp. and Ur-Energy have no signed contracts as of yet.”
So what’s the deal with the Long Term Price of Uranium?
Schatzker and Phillips opine “It has been an anomaly to many market watchers as it (the long term price of uranium) has remained unchanged at $95 per pound U3O8 since May 2007; the long-term price did not increase with the spot price in the spring/summer of 2007, nor is it trending down now that the spot price has decreased to the mid-$60 per pound range. Market insiders believe the long-term price is a better gauge of the perceived longer-term supply-demand imbalance and that it, in some ways, is a better indicator of market sentiment than the spot price. Transactions at the spot price only account for about
10% of annual U3O8 demand. However, in our opinion, no company can sell all its U3O8 material at the long-term price since no utility or buyer is willing to fix at such a perceived "high" price for longer-term supplies. When the spot price was high, both buyers and sellers were more willing to enter into spot market-related contracts, but for the exact opposite outlook on spot U3O8 prices: sellers thought the price would continue higher and buyers thought the price would fall.”
Will the Spot and Long-Term Converge? And if so, how?
Schatzker and Phillips write “Market watchers may wonder why there is a $30 per pound gap between the spot and long-term price and why arbitrage has not reduced the difference. We believe the gap is explained by the differing nature of the two prices and illiquidity in the spot market. Spot is being driven lower by strong selling and weak, discretionary-based buying, while the long-term price is a negotiated price that does not affect a large portion of the material. We think the long-term price will track the movement of the spot price over the longer term, but, in the near-term, the market appears to be in equilibrium at $95 per pound. We still believe the spot price will rebound and approach the long-term price in the next 6 to 12 months.”
Timing Difference between New supply and New demand?
“New supply has already come to the market and more is expected - permitting delays for mines can be long, but no longer than delays for approving new nuclear plants. We have yet to see new builds for nuclear plants given the green light in Canada, the U.S. or most of Europe; however, we believe that approvals will eventually be forthcoming and we believe that the demand for these new reactors will affect the uranium market outlook long before these new reactor plants start producing.”
Conclusion
Schatzker and Phillips believe “the uranium spot price is not necessarily the best indicator of the state of the uranium market since the spot market is thin and illiquid and we think that it is prone to skewed movements caused by large, irregular transactions. The long-term price is also an imperfect metric since it is only applicable to a narrow portion of U3O8 contract sales. However, we believe that the real clearing price for the market lies somewhere in between the currently-quoted spot and long-term prices. In our view, if all material were to be sold on the spot market today, an equilibrium price would likely be in the $85-$100 per pound range given the demand-supply fundamentals and the ever-increasing cost of new mine production.”
Valuation and Target Prices
With regards to the valuations of Uranium equities, Schatzker and Phillips write “While the equities have overall come down mostly in line with the uranium price, we think some have come down too much, while others are relatively over-valued. The equities we believe to be fully or over-valued in the current market are also implying uranium prices substantially higher than their peers. Further, the uranium prices implied by the share prices of the companies we feel are overvalued are also much higher than the current spot price of uranium.
For exposure to near-term appreciation of the uranium price, we continue to recommend Cameco. For longer-term exposure to the uranium market, our preferred equities are: First Uranium, Aurora Energy and Ur-Energy.”
PRODUCERS
Cameco Corp. (US$44.58/lb U3O8)
TSX-CCO: $36.36, Outperform, Above Average Risk, 12-Month Target Price: C$49.00
"Cameco is trading at an implied price that falls toward the lower end of the group. We believe that Cameco will likely continue to be the best name among uranium producers, especially since the water-related risks at Cigar Lake have been reduced recently and it has a top-tier asset base that is in production. Cameco’s contract structure should provide the company with increasing uranium price realizations over the next decade.
Paladin Energy Ltd. (US$90.00/lb U3O8)
ASX-PDN: A$4.10, Sector Perform, Above Average Risk, 12-Month Target Price: A$5.00
We believe the market is currently attributing substantial value for Paladin's exploration and development projects including Valhalla/Skal (a project we have modeled using a DCF method). We think this is because Paladin continues to be a "go to" name in the uranium space, but its valuation stands out from the pack on the high end: the current share price is discounting 2.2 times our estimated NAV. We think that Paladin’s management has set the bar quite high with new guidance, especially for Phase III at Langer Heinrich, and that this increases the company’s execution risk.
Uranium One Inc. (US$69.35/lb U3O8)
TSX-UUU: C$4.87, Sector Perform, Speculative Risk, 12-Month Target Price: C$4.00
Uranium One has traded up sharply from its recent low of C$3.04 as we believe investors are looking to buy based on the notion that it was oversold. However, its recent climb toward $4.90 reflect, in our view, a full valuation. We continue to believe that there are still many risks to the company’s assets, in particular its Dominion mine (performance risk) and the Kazakh assets (political risk). Uranium One is currently trading at 1.2 times our NAV estimate and with P/E multiples that are well above its peers.
DEVELOPERS
First Uranium Corp. (-US$3.27/lb U3O8)
TSX-FIU: C$6.32, Outperform, Above Average Risk, 12-Month Target Price: C$11.25
First Uranium is primarily a gold company and is trading well below our estimated NAV of $13.14. We are not surprised that it is trading at a negative implied uranium price given our view that the stock is trading as a “cheap” gold company with “free” uranium exposure. We think that the successful execution of the company’s near-term milestones, including the start of operations at the Ezulwini mine this month for gold and June 2008 for uranium should provide positive catalysts for the shares. The shares are currently
discounting a flat $630/oz gold price. We expect First Uranium will be able to execute its business plan with less risk than its peers given the extensive and conservative engineering work that has been carried out. At its current share price its is trading at 0.5 times our estimated NAV and has forward P/E multiples that are the lowest in its peer group (for 2010E to 2012E).
Ur-Energy Inc. (US$44.66/lb U3O8)
TSX-URE: C$1.64, Outperform, Above Average Risk, 12-Month Target Price: C$3.50
Ur-Energy is discounting approximately $45 per pound at its current share price level, a value that has fallen over time, much like its peers. Ur-Energy is well cashed up and we continue to believe it is a potential takeover target.
Uranium Energy Corp. (US$51.42/lb U3O8)
AMEX-UEC: C$2.38, Sector Perform, Speculative Risk, 12-Month Target Price: C$4.25
Uranium Energy is, like Ur-Energy, developing a US-based ISR uranium mine (this one in Texas, Ur-Energy in Wyoming). The difference, in our opinion, is that Uranium Energy will likely face significant opposition to its plans that will delay production and it will need to raise equity in the near-term.
EXPLORERS
Aurora Energy Resources Inc. ($44.47/lb U3O8)
TSX-AXU: C$3.64, Outperform, Speculative Risk, 12-Month Target Price: C$8.00
Aurora’s current share price is discounting a constant uranium price that is not much lower than some of its peers; however, given the leverage to higher uranium prices that we estimate the company has (e.g. for each US$5 per pound change in realized uranium prices, our NAV estimate increases by $0.80 per share), relatively small changes to the long-term uranium price drive large changes to Aurora’s NAV. Our long-term uranium price is US$45 per pound; but, we assume that Aurora will contract the early years of its production at prices closer to US$80 per pound.
Berkeley Resources Ltd. ($52.18/lb U3O8)
ASX-BKY: A$0.80 Outperform, Speculative Risk, 12-Month Target Price: A$1.50
Berkeley is actually receiving a slight premium to its exploration/development peers. We believe that is likely due to the perceived option value that is embedded into the share price relating to the potential outcome of ongoing negotiations with the Spanish government and to reflect the value of its other, active, exploration projects in Spain.
Conclusion
Based on the information presented above, we think that some of the equities are trading at fairly high levels (e.g. Uranium One and Paladin) and that this premium may come down. However, both Uranium One and Paladin are “the” growth companies in the uranium industry and investors have tended to flock to them when they put money into this industry.”
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