Metals commentary: Getting ahead of the uranium curve

Compelling supply-demand fundamentals and near-term industry catalysts will spark a recovery in uranium prices and equity prices, David Sadowski of Raymond James argues in a weighty new report running 86 pages.  

The Vancouver-based mining analyst argues investors should own positions in uranium equities ahead of a potential rebound in the sector that he anticipates will get underway in the latter half of 2012 and into 2013. He has resumed coverage of the industry and raised his six- to 12-month target prices significantly on Cameco, Denison Mines, Paladin Energy, Ur-Energy, Uranium One and Uranium Participation.

Historically uranium equities have traded at premium multiples to other metals, he says. But price to net asset value multiples have “compressed significantly” in recent months, with the uranium producers he covers trading at 0.83 times and developers and explorers at 0.51 times. By contrast, between January 2010 and the Fukushima nuclear disaster in March 2011, Cameco, Paladin and Uranium One averaged 1.33 times while developers Denison Mines, Ur-Energy and Strathmore Minerals averaged 0.71 times.

Sadowski believes China will resume approvals of new reactor projects before year-end and expects further restarts of reactors in Japan,with the next batch of reactors in the country resuming operations early next year, and the start up of most of its reactors by 2017. He also notes that utilities in Japan together hold “one of the largest commercial uranium inventories globally, given a conservative mentality of safeguarding against supply disruptions, coupled with the third-largest reactor fleet in the world.” And with future operations of reactors up in the air, he adds that “this material has been somewhat of an overhang in the market, as, according to UxC and others, many buyers were holding off on purchases to see if this uranium was going to become available. Restarts could remove the overhang, supporting prices in the near-term.”

He also points to the expiry in December 2013 of the Russian Megatons to Megawatts agreement, a deal spanning two decades that involved down-blending 500 tonnes of highly enriched uranium (HEU) from Russian warheads into 400 million lb. uranium oxide (U308).

“The Russian government has repeatedly stated it has no interest in an extension,” he writes, noting that on average in 2011 the HEU-derived material made up 13% of total global uranium supply, and was relied upon to fill the gap between mine supply of about 138 million lb. and total demand of about 184 million lb.

“We expect a market response in advance of expiry of the agreement,” he reasons. “Once the deal ends, utilities will have to look at more traditional sources (e.g., long-term contracts with producers or the spot market) to shore up their future needs, which should put upward pressure on prices.”

The analyst also believes that the nuclear outlook post-Fukushima is robust on the back of growth in Asia and the Middle East and cites estimates from the World Nuclear Association of 498 planned and potential reactors, which is higher than the group’s estimate of 478 in April 2011 prior to the Fukushima disaster. And while he concedes the build-out is likely to be “slower and more cautious” — something he views as being “good for the long-term health of the industry” — he remains convinced that global nuclear demand, especially in Asia and the Middle East, “remains resilient on ramping electricity demand, fossil fuel price volatility, energy supply security concerns and few green alternatives to meet base-load requirements.” He also points out that in Asia and the Middle East, governments can “more easily clear the upfront costs, public opinion and regulatory hurdles facing newbuild than in much of the western world.”

In the Middle East specifically, according to figures from the World Nuclear Association, there were five planned reactors and five proposed in 2007. But these figures have grown to 12 planned and 48 proposed. Turkey wants to have a minimum 23 reactors by 2023 and Saudi Arabia wants 16 units by 2030. The United Arab Emirates is also becoming active and has awarded a South Korean consortium a contract to build four reactors by 2020.

“If realized, these Middle East units more than offset the planned phase-outs in Germany, Switzerland and Belgium,” Sadowski maintains. Meanwhile in South Asia, India has “highly ambitious” plans to grow its nuclear capacity from today’s 4 gigawatts (GW) to 63 GW by 2032.

On the supply-demand front, uranium prices that have been languishing in the low US$50s per lb., and overall uncertainty in the industry has caused a number of project delays and deferrals. Sadowski estimates that “the majority of planned or potential new supply require prices in the upper-US$60s per lb., or higher to incentivize positive production decisions . . . prices today are simply too low to justify the financing risk of building new mines or expanding existing ones.”  

In addition he forecasts further supply disruption, such as the flooding at Cigar Lake in 2006 that resulted in part in the doubling of the uranium price from US$36 per lb. to US$72 per lb., and more recently shaft damage at Olympic Dam and flooding at Ranger and Rossing.

Looking ahead he predicts that a three-year-long uranium deficit beginning in 2014 will drive prices higher, and believes there will be increasing activity on the merger and acquisition front. Merger and acquisitions in the last year alone, he points out, included a bidding war between Rio Tinto and Cameco for Hathor, selling Denison’s U.S. operations to Energy Fuels and China Guangdong Nuclear Power Holding acquiring Extract Resources.

“We believe this trend is likely to continue,” he contends, “given current near-trough equity valuations, healthy balance sheets at many of the larger players [Cameco, Uranium One, state-owned utilities] and weak balance sheets at others [Areva, Paladin], ambitious nuclear build-out plans in Asia [and commensurate uranium requirements] and a scarcity of high-quality projects, which could spur potential buyers to beat out others for prime assets.” He also makes note of China’s stated 2012 ambition to “buy uranium mines abroad, particularly in Canada [China Daily, March 3/12] and Korean utility Kepco’s plans to spend US$1.8 billion in 2012 on overseas nuclear plants and uranium mines [Bloomberg, April 2/12].”

Sadowski has a six- to 12-month target price on Cameco of $28 per share [up from its current $22.34 share price], a $1.80 price target on Denison Mines [up from $1.33], a $1.80 target on Paladin [up from $1.12], a $1.50 target on Ur-Energy [up from 67¢] and a $3.60 target on Uranium One [up from $2.46].

He also has an $8 target price on Uranium Participation Corporation, the world’s only publicly traded physical uranium fund. The fund is managed by Denison Mines and “offers pure-play exposure to any rebound in spot prices, with minimum operational risk.” The fund holds 13.4 million lb. U308 equivalent and trades at 0.87-time price to net asset value.