On May 13, 2008 Cameco reported its financial and operating results for Q1/08.
Company Profile (from Reuters)
Cameco Corporation is a Canada-based company. The Company operates in four segments: uranium, fuel services, nuclear electricity generation and gold. During the year ended December 31, 2007, Cameco's fuel services business consisted of uranium refining and conversion facilities in Ontario, a Candu fuel fabrication facility in Ontario and a uranium conversion services supply arrangement with Springfields Fuels Ltd (SFL). In July 2007, Cameco acquired a 10% interest in Western Uranium Corporation (WUC).
Click here to view previous coverage of Cameco (CCO: TSX, CCJ: NYSE) and the Uranium market from April 29, 2008
Takeaways From The Event
For Q1/08 Cameco reported net earnings of $133 million ($0.37 per share diluted) on revnue of $593 million which was 45% higher than Q1/07. The company reported that interest and other charges were $36 million higher than in the first quarter of 2007 due primarily to the recognition of $34 million in mark-to-market losses on hedge contracts that do not qualify for hedge accounting. Cameco also recorded Interest and other charges were $36 million higher than in the first quarter of 2007 due primarily to the recognition of $34 million in mark-to-market losses on hedge contracts that do not qualify for hedge accounting. Cameco reported that their total cost of products and services sold, including depreciation, depletion and reclamation (DD&R), increased to $168 million in the first quarter of 2008 from $123 million in the first quarter of 2007 due to the rise in reported sales volumes and an increase in the unit cost of product sold. The unit cost increased by 15% as a result of higher production costs and higher royalty charges, which increase with the realized price. Lastly, the company noted that the prices realized for their uranium business lagged the market and continued to rise in the quarter despite lower market prices.
Responding to Cameco’s earnings, CIBC World Markets analyst Cliff Hale-Sanders writes “Cameco reported Q1/08 earrings of $0.37, which while up from the $0.16/sh reported in Q1/07, still failed to meet consensus expectations of $0.42/sh and our forecast of $0.47/sh. After adjusting for various one-time items, we estimate operating earnings were $0.31/sh. The variance can be attributed to the lumpy nature of Cameco's uranium sales on a quarterly basis, which was below our forecast; but full-year guidance remains unchanged. Also, lower contribution from Bruce Power and higher costs were somewhat offset by strong results from Centerra. The company left 2008 guidance essentially unchanged and the market awaits firm details of the Cigar Lake remediation program now that the plug is holding. Going forward in 2008, uranium deliveries are now expected to be 32 to 34 million lbs, up slightly from the last guidance of 31 to 33 million lbs, resulting in Cameco anticipating an increase of about 10-20% in revenue from uranium operations (up from last projection of 5-15%). We use 32 million lbs in our forecasts to reflect the uncertainty at the Inkai operation where constraints on the availability of acid could impact production. On the mine production side the outlook for 2008 remains largely unchanged from the last guidance with annual uranium production of 20.6 million lbs. Cameco has arranged a new a standby product loan facility with one of its customers that allows Cameco to borrow up to 2.4 million lbs of U3O8 (valued at about US$217 million) over the period of April 1, 2008 to December 31, 2011 with repayment in 2012 through 2014. This should provide Cameco with increased flexibility to meet its obligations. Also, work at Port Hope remains ongoing and we should see this division improve later in the year. While results were mediocre at best, Cameco remains the premier uranium play at a time when investor interest in clean power and concerns over carbon taxes is increasing.”
With regard to Cigar Lake, Hale-Sanders’ notes that “the company has noted that the plug installed to contain the water inflow appears to be holding over 95% of the inflow back and that it has finalized an assessment of two other areas of the mine that needed to be completed prior to dewatering the underground workings. With this completed Cameco indicated that it has submitted its application in April to the CNSC to allow dewatering of the underground development and all other remediation activities leading up to, but not including, the restart of construction underground. The application also included completion of the second shaft and other activities. CNSC approval is needed before any dewatering activity can be carried out. This timing of the review process is somewhat uncertain, however, it is expected to commence in the near future. Until Cameco has completed dewatering of the mine and has a chance to review the underground workings directly, it is leaving its target for the restart of the mine as being 2011 at the earliest. Once underground the company would be a better position to reflect on the timing of production restart and the expected costs.”
Concerning Cameco’s on-going re-negotiation of the HEU agreement with Tenex, Hale-Sanders’ writes “Cameco currently purchases about 7 million pounds of uranium annually under this commercial agreement, which ends in 2013. The purchase price that Cameco pays for these pounds was agreed to in 2001, when uranium prices were much lower than they are today. In our forecasts we have assumed a purchase price of less than US$10/lb. Tenex has asked the parties to consider a new pricing structure to share in the improved uranium market prices. While the future outcome of this request in highly uncertain given the highly political nature of the original agreement, the actions of Russian oil and gas dealings over the past few years suggests Tenex will vigorously pursue a repricing of the contract. Currently Cameco acquires the material at a fixed price and then re-sells it into its long-term contract, pocketing the profits. Clearly if the purchase price is renegotiated, Cameco’s profitability levels will come under significant pressure and put into question not only our earnings and cash flow forecasts but also the company’s valuation. In the event that a deal is not reached Tenex could, in a worst case scenario, withhold the material resulting in a significant supply shortfall in the West that could cause prices to spike higher. In our forecasts for Cameco a US$10/lb change in the purchase price would impact our forecasted EPS by around $0.17 and our NAV by $0.77/sh. Given that any pricing change is likely to be well above US$10/lb the impact will be a multiple of our sensitivity. Cameco believes any repricing would only affect the final couple of years of the agreement. Negotiations are expected to take until 2009.”
Looking at the recent Uranium market, Hale-Sanders’ notes “Of late the uranium market has been looking somewhat less than encouraging in terms of the direction of short-term prices. Spot prices have continued to decline from the high of US$135/lb in 2007 and now sit at only US$60/lb. That said, long-term prices remain quoted at US$90/lb. Short-term prices have remained under pressure and will likely stay that way in the near term given the lack of demand from utilities. Utilities are reported as well covered for the next several years and as such there is little need for them to look to increase inventories in the spot market and any buying will likely be discretionary. That said, consumers continue to be willing to pay a premium for longer supply to ensure security of supply and some concerns over the long-term price. Further the spread between spot and long-term prices is not expected to be sustainable as many contracts make reference to the long-term or spot price. As such, this gap can be expected to close over time. Our forecasts continue to indicate prices should recover over the next year or so to continue to encourage development within the industry without which the so-called renaissance will not be able to occur. With the pullback in the spot price we continue to look for Cameco’s realizations to continue to improve, however, the rate and degree of the improvement remains unclear at this time given the changes in the spot market. While short-term prices are clearly highly volatile given the potential influence of short-term players, the longer-term outlook for uranium demand and thus prices remains healthy as the world looks for new sources of cheap and clean base load power generation capacity. While the irrational view of the uranium price seen last year has abated, we believe this now positions the industry for a longer term period of growth at robust prices relative to levels seen over the past few decades. We continue to view our long-term, non-inflation adjusted price of US$50/lb as conservative. Clearly with uranium prices going down the recent strong performance of Cameco’s shares suggests correlation to short-term moves in uranium prices are somewhat muted at this time. We attribute this to Cameco being lumped into the overall energy investment theme as correlation to rising oil prices remains a dominate factor for Cameco’s share price performance. That said, we believe the strength in oil only underscores the long-term potential offered by uranium power to offset energy needs and green house gas emissions in a period of rising carbon taxes. As such, investors could be looking through the short-term issues.”
Lastly, after analyzing Cameco’s results Hale-Sanders revises some of his forecasts for Cameco. His “2008 EPS/CFPS forecasts have changed to $2.02/$2.55 from $1.98/$2.61,and our 2009 EPS/CFPS forecasts have increased to $2.22/$2.99 from $2.07/$2.80. The increase in 2009 reflects the stronger equity accounted for contribution from Centerra.” His forecasts are based on his “uranium price assumption of US$82/lb for 2008 and US$80/lb for 2009. Given current spots price of only US$60.00 per pound, if prices do not post a recovery in the near term our forecast could prove aggressive as the rate of uranium price realization growth would slow. Our forecasts do not incorporate a re-pricing of the HEU contracts at this time.”
However, despite Cameco’s shortcomings Hale-Sanders increases his target multiple on the shares to “reflect Cameco’s unique position within the market to capture the growing interest in clean power generation that will support the nuclear renaissance and the increased implementation of so-called carbon taxes, which should make nuclear power even more competitive over the long term (assuming, of course, the market can address the supply side issues and the dearth of skills to support the rapid build out of the reactor base).”
Hale-Sanders maintains his Sector Performer rating but increases his target price to $45.00 (from $41.00). His target price is obtained from “a compilation of various valuation approaches, such as NAV, P/E and P/CFPS. We have relied most heavily on our expectations of the company’s NAV and the potential earnings and cash flow derived valuation approaches. To derive our price target, we apply a 1.5x multiple to our valuation of the uranium division and then add the current market values for Cameco’s investments in Centerra Gold and UEX Corp. (UEX– TSX). We then net that with the company’s current, unconsolidated balance sheet. We use a 1.5x multiple to our 8% discount rate NAV to reflect the unique nature of Cameco’s position within the uranium business and to reflect the leverage in our valuation to higher long-term uranium prices relative to our US$50/lb. forecast. This multiple also captures some of the intangible assets, such as the company’s exploration portfolio and market dominance.”
Investment Risks
Without limitations, some of the risks include reserves and resource risk, development risks, permitting risks, off-take agreements, commodity price risks, geo-political risks, exchange rates, weather related impacts etc.
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