Uranium's Hot, But This One's Not: The Short Case On USEC (USU)

Jul. 7.06 | About: Centrus Energy (LEU)

Not all uranium plays are created equal. While I'm bullish on the outlook for uranium prices in general, USEC, Inc. (USU) would be the one stock in the group to avoid.

USEC supplies low enriched uranium for nuclear power plants. USEC has lived off a twenty-year advantageous Russian contract for uranium. As a producer of enriched uranium, USEC is inefficient and needs to raise large amounts of capital (almost 1.5 to 2x its market capitalization). Further competition will beset USEC given the July 5, 2006 announcement that Urenco will build a plant in New Mexico scheduled to start producing in 2008.

Here's my short thesis for USU:

a. Improved recent cashflow improvements are not sustainable and have not come from the core operations of the company but rather from sales of stockpiles of uranium. This source of earnings will dry up in late 2006 and beyond. (See John Dizards column in Financial Times Tuesday June 13 2006).

b. USEC needs to do an equity deal in the next few months to start to fund its new American Centrifuge plant. Total cost expected to be $1.7bn and first raising greater than $500M.

c. Technology risk on the new plant. While management proclaims that the American Centrifuge plant will be much more efficient than their competitors, this is a huge centrifuge which is hard to build and is not designed on a scale that has been proven.

d. New electricity contracts guarantees that 2H 2006 and 2007 earnings will remain depressed as dramatically increased rates (upto 70% with guaranteed buy provisions) flow through the income statement.

e. Tough new competitor called Urenco enters into the US market in 2008. USEC has about 50% market share in the US currently. Urenco is a company with deep pockets and proven operating record in Europe.

f. Valuation not attractive – cashflow has peaked in the first half of 2006 and drops dramatically into 2007.

g. Current sunset review of the Russian Suspension agreement which may impact USEC dramatically.

Company data (all in US Dollars):

Price: 12.00
Year End: Dec
Shares O/S: 87m
Market Cap: 1.0bn
Net Debt: 150m
EPS 2005A: 0.26
EPS 2006E: 0.79
EPS 2007E: 0.48
P/E 2006: 15x
P/E 2007: 25x

USU 1-yr chart:

USU 1-yr

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Author's update, 7/18/06

On July 17, FBR (Friedman, Billings Ramsey) placed USEC on their "Top Picks List." Their reasoning was as follows. USEC's downside was likely limited, because the company has inventory in uranium worth the whole market capitalization of $13. Further, FBR took a long-term view on American Centrifuge - claiming it could do $1bn in EBITDA in 2013. FBR also took comfort in the high level of interest in uranium stocks and declared USEC a "pure play on the developing nuclear renaissance."

FBR put a price target of $27 on the stock.

My reasoning on the stock remains unchanged.