As the year 2012 drew to a close, Japan's policy makers began retreating from earlier decisions to shutter many of the country's nuclear power plants. No one can blame the Japanese for turning wildly negative on nuclear power after the disaster at Fukushima where flooding from tsunami waters led to one of the worst nuclear emissions in history. The citizens lost confidence in their ability to maintain safety. However, Japan's new prime minister, Shinzo Abe, is scheduled to unveil a new energy policy in early 2013 that is expected to undue plans to eliminate the country's nuclear power capacity.
Such a high profile decision is likely to cast a few rays of sunshine on the nuclear sector. Could a shift in political sentiment lead to a positive shift in investor interest in the sector? Stocks of uranium miners have been depressed over the past year, thus it seems particularly timely to enter the sector. This line of reasoning sent me shopping for a uranium mining company with compelling fundamentals and valuation.
Since the U.S. is the largest consumer of nuclear materials, it makes sense to begin the search with U.S. nuclear mining companies. Cameco Corporation (NYSE:CCJ) is one of the largest of uranium miners with operations in the U.S. It is the third largest uranium producer in the world behind KazAtomProm in Kazakhstan which supplies 17% of total production and just equal to the 16% market share of France's Areva (OTCPK:ARVCY). In terms of production only in the U.S. market, Uranium One, Inc. (UUU.TO) is the second largest producer with capacity near 3.8 million short tons per year. Power Resources, Inc. has amassed the largest capacity in the U.S. near 5.5 million short tons, but as a privately held company leaves little opportunity for minority investors.
This is very impressive, but I believe balance sheet strength and financial flexibility rather than size could be a better screening criteria. That approach puts Uranium Energy (NYSEMKT:UEC) at the top of the list. It has the least leverage of all in the group with a debt-to-equity ratio of 0.02 compared to the sector average near 14.50.
Demand and Pricing
Why is financial flexibility so important? By most accounts, demand conditions for uranium producers are looking good. According to joint research by the OECD Nuclear Energy Agency (NYSE:NEA) and the International Atomic Energy Agency (IAEA), by the year 2035 world nuclear electricity generating capacity is projected to grow to an estimated range of 540 gigawatts to 746 gigawatts from 375 gigawatts in 2010. The increase in generating capacity is principally from new power reactors. The World Nuclear Association counts 65 new nuclear reactors under construction in 2013. Accordingly, uranium requirements for world nuclear reactors are projected to rise from 63,875 tons of uranium metal at the end of 2010 to between 98,000 tons and 136,000 tons by 2035.
What is more, industry analysts are forecasting higher selling prices. A Credit Suisse report suggest prices in a range of $80 to $90 per pound in 2013 and J.P. Morgan projects a price range of $78 to $85 per pound. This would represent a significant increase from recent spot prices that fell to a low of $45 per pound. Big firm predictions are often times just wishful thinking. However, investors should note that one of Australia's more important uranium mining companies, Paladin Energy Ltd. (OTCPK:PALAF), recently received a $200 million pre-payment from a utility for up to 14 million pounds of uranium to be delivered beginning in 2019. It is an unprecedented supply agreement that signals supply concerns among uranium users - and quite a bit of support for aggressive price forecasts by industry analysts.
Uranium Energy currently produces uranium at its Palangana mine located in the so-called Texas uranium belt and very near the company's Hobson Processing Facility. In fiscal year ending July 2012, the Palangana mine produced 183,000 pounds of uranium concentrate using in situ technologies, while the Hobson facility processing 323,000 pounds. The company reported its first sales in late 2011 and in fiscal year ending July 2012 sold a total of 270,000 pounds of uranium at an average price of $51 per pound.
In addition to the Palangana operation, Uranium Energy has a number of leases in the state of Texas. The most promising might be those in Goliad County that include twenty leases over 2,000-plus acres. The properties comprising the Goliad Project is used mostly for livestock grazing pasture and woodland. No historic mining has been conducted in the area, but the Goliad properties show promise for the in situ technologies that Uranium Energy prefers.
The company indicated in its fiscal year 2012 financial report that a total of 958 confirmation-delineation holes totaling 338,615 feet have been drilled on the Goliad property. Two of four samples tested by an independent laboratory contained approximately 0.08% uranium concentration and two contained lower grades of uranium, i.e. approximately 0.04% concentration. The company has accumulated several of the mining and environmental permits required, but is still awaiting Department of Environmental Protection approval related to water supplies.
In addition to properties in Texas, Uranium Energy has mineral rights in Arizona, Colorado, New Mexico and Paraguay. The company professes plans to carry out exploration programs on each of these properties. As yet economic concentrations of uranium have not been proven on these tracts.
Uranium Energy has spent significantly to expand and capitalize on its mineral properties. In the October 2012 quarter, the company reported $4.4 million in mineral property expense on top of $14.9 million spent in fiscal year 2012. The investment burden is significant so a strong balance sheet is critical. As I noted above Uranium Energy has no debt. The company also has $17.7 million in cash on its balance sheet. Granted the cash requirement to support operations was $22.2 million in the twelve months ending October 2012. Without any change in revenue and spending patterns, investors can expect Uranium Energy to last only through the end of the third quarter 2013, without raising additional capital.
However, if industry analysts are right in the forecast of price changes, the prospects to higher cash flows are excellent in the near term. At the end of October 2012, Uranium Energy had 34,000 pounds of uranium available for sale along with new production. With an increase in prices, the company could realize significantly improved profits and cash flows. I am not alone with this line of reasoning. At least one of the four analysts who have published estimates for Uranium Energy, expects a swing to profitability in fiscal year 2013. According to Thomson-Reuters the consensus fiscal year 2013 earnings estimate is $0.12 per share on $63.4 million in total sales.
Some investors might cry foul in the selection of Uranium Energy as the most promising of U.S. miners. In terms of comparable uranium miners, UEC is trading at higher than average multiples of historic sales and book value. That said, the stock is priced at 20.4 times the consensus estimate for the current fiscal year. In my view that is a compelling valuation, considering the flip to profitability and prospects for exceptional growth in sales and earnings that demand and supply conditions support.
Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.