Despite the negative media surrounding Uranium, it is hard to argue that there will not continue to be growth in the demand in this sector in response to growth in China and other developing economies. Uranium is still the most efficient energy source available, and Cameco (CCJ), given its size and high quality resource base, is well positioned to monopolize on this.
COMPANY BACKGROUND: The top uranium player
Cameco is the world's largest producer of U3O8 uranium, a mineral whose only commercial use is to fuel nuclear power plants, and the second largest uranium producer in the world, behind Rio Tinto. Nuclear power accounts for around 15% of the world's electricity, and CCJ accounts for 20% of world uranium production, with 1010 million pounds of proven and probable reserves (53% more than any other publicly listed company).
CCJ is involved in all stages of the uranium mining process, which includes exploration, fuel fabrication and electricity generation. As one of only three conversion suppliers in the western world, CCJ controls about 40% of the western world's capacity to produce uranium hexafluoride (UF6), a compound used in the uranium enrichment process that produces fuel for nuclear reactors.
In CCJ's 3rd Quarter financial results, company officials stated that the company remains confident in the long-term fundamentals of the nuclear industry, with 64 reactors under construction today and 80 net new reactors being planned. However, uncertainty due to recent developments in the nuclear industry (primarily centered around Japan) has led CCJ to revise Greenfield growth plans and to focus on expansion of existing brownfield assets.
After a decade of falling mine production to 1993, output of uranium has generally risen since then and now meets 85% of demand for power generation. About 64 percent of the world's production of uranium from mines is from Kazakhstan, Canada and Australia; CCJ has major assets in all three of these countries and is geographically positioned to service the growing power requirements of the developing Chinese power market.
CCJ business segments include:
•Uranium (approx. 44.7% of total revenue);
•Nuclear-generated Electricity (approx. 47.3% of total revenue); and
•Fuel services (approx. 8% of total revenue)
INVESTMENT THESIS: Overreaction by investors
Uranium stocks have been weakening since early 2011. This is primarily due to the Fukushima disaster, subsequent uranium oversupply and a weakening in price. During this period CCJ shares have declined 60% in value (refer to plot of historical share price on previous page).
More specifically, reasons for decline in stock value include:
•Decline in uranium prices and reduction in short to medium term price forecast;
•The subsequent reduction of profits reported in Q3;
•Slightly increased production costs;
•Shelving of a number of growth opportunities;
•Reduction in number of forecast new reactors (from 93 to 80); and
•Uncertainty of Japanese policy makers following the Fukushima disaster (decision on whether to phase out nuclear power due within the next 6 months).
I believe that over the past few years the market has overreacted to this combination of factors; anticipating a Uranium 'doomsday'. However, investors have only just started to wake up to this fact and as a result, we've observed a 10% increase in CCJ stock value since late November 2012.
(click to enlarge)
Figure 1 - CCJ historical 5 year stock price [courtesy of Seeking Alpha
CCJ, as the world's largest Uranium producer and owner of the world's highest grade uranium ore-body, has low cash costs per unit (CDN$21.11/lb [source: Cameco homepage]), well below that of its smaller competitors. Therefore, I believe, it is in superior position to its competitors to ride out the low uranium price that are expected in the short-term (Uranium price is currently ~CDN$40/lb). Once surplus uranium stockpiles have been depleted (expected in 2013), I expect demand will return to historically normal levels and I expect an increase in uranium price and a subsequent increased sentiment from uranium stock investors.
Figure 1 and Figure 2, below, present a comparison of both CCJ's historical share price to historical uranium prices per pound. It is evident that there is a strong relationship between the two. I was surprised to see that the mirrored trends are not observed to be led by CCJ; I would have expected a the uranium price (Figure 1) to lag slightly due to the release of uranium price forecasts). Since it doesn't appear that the stock doesn't fluctuate on the basis of future uranium prices, this would suggest that the right time to buy CCJ stocks is when the uranium price are at their lowest (i.e. when uranium demand is at its lowest, which may have just passed given the Japanese situation and global oversupply).
Figure 2: The Price of Uranium (Oct 2007 - Oct 2011)
Figure 3: Cameco Corp. Share Price (Oct 2007 - Present), Figure courtesy of Yahoo Finance
Variability and uncertainty in future uranium price forecasts weigh heavily on CCJ stocks. I feel investors are over-reacting to these factors (last week CCJ stocks were at 5 year lows). In practice CCJ buffer against these price fluctuations by structuring payments in a portfolio including a mix of fixed-price and market-related contracts (40:60 ratio).
The following table shows the sensitivity of CCJ's revenue/tonne for uranium spot price variations, in consideration of current contracts. This table demonstrates that CCJ's received price is significantly different from what the Uranium spot price market would indicate; however CCJ stocks take little consideration of this. NOTE: CCJ states that a number of these contracts were made when market prices were low (US$11-$31). Those that are fixed at lower prices or have low ceiling prices will yield prices that are lower than current market prices. These older contracts are beginning to expire, and CCJ are starting to deliver into more favorably priced contracts. (Source: Cameco Homepage)
Table 1 - The sensitivity of CCJ's revenue/ tonne for uranium spot price variations, courtesy of the official Cameco website
In addition to over-reaction to pricing, I also believe that investors are over-reacting to news of reduced growth. Whilst forecasts have reduced slightly, there is still significant forecast growth in the demand for uranium in the medium to long term, with 16% growth in the number of reactors to 2021. Further, there are 65 new reactors already in construction. (Source: Cameco)
China has an 80-gigawatt (GW) goal by 2020 and have released their new five-year energy plan, lifting the moratorium on new nuclear builds. This is a huge industry catalyst that paves the way for more reactor construction. Although there's a ban on building inland nuclear plants, there are 27.5 GW of capacity that can be approved for construction in the coastal provinces. Many believe there will be more approvals coming. [Source: ninemsn Finance]
The table below shows the outlook for planned reactors. With CCJ's competitors shelving of almost all major Uranium growth projects internationally, CCJ appears to remain committed to modest and careful growth of existing operations - which will make them well positioned to serve an increase in uranium demand.
Figure 4 - New and previous build outlook for nuclear reactors, courtesy of the official Cameco website
RISKS/ NEGATIVES: Uncertainty as to the 'when' for Uranium
Investing in CCJ comes with a number of risks, including:
• Due to low demand and the resulting prices, the key ratios of P/E (13.45), PEG and high P/S ratio are relatively high and appear to ; represent terrific value (although still lower than the majority of its peers).
•Not a great dividend yield (only 2.4%);
•Sensitive to uranium price means that a sustained reduction in uranium price would reduce stock value;
•Analysts across the industry have been calling a bottom in spot prices for months now, yet prices keep sliding further.;
•CCJ's profit is sensitive to changes to the US/ CAN dollars;
•The business has no control over the aforementioned prices;
•The Japanese policymakers may try to phase out nuclear power (although this has received resistance) which upon announcement would reduce future global demand adversely affect stock value.
•There is a significant variation in reported forward P/E forecasts by different stock analysis sources, which indicates high uncertainty in the stock and inevitable risk.
CCJ does not appear a particularly attractive stock upon sole observation of the stock fundamentals. It does not possess a particularly high dividend yield (at only 2.4%) and has a relatively high Price to Earnings (P/E = 16), Price to Earnings and Growth (PEG = 2.10) and Price to Sales (P/S = 3.36). However, these ratios are likely to move favorably as stocks in China deplete, and demand and price increases.
Further, CCJ is inherently a risky stock due to its dependence on both the price of uranium and of the US/CAN currency.
Despite the stocks risks, I believe it is still under-valued compared to its peers; due to market over-reaction on multiple factors (including the uranium outlook, Japanese policy uncertainty and growth forecasts).
CCJ appears to be in reasonable shape as a business, with low debt and is well positioned to benefit from any growth in Uranium demand and in my opinion its near 5 year lows are unwarranted.
I believe that the inevitable positive news of a forecast recovery of uranium prices will create significant investor interest and a potential surge in the stock, given the almost 5 year low stock prices. This should create significant stock growth in the medium term.
Granted, the stock was most attractive in November during which time it was trading at near 5 year lows. At this point, shares of CCJ entered into oversold territory (indicating that the selling process was exhausting itself). Whilst there has been a slight rebound since, I think that this stock will continue to increase in value in the range of 10-20% through 2013.