"There is a tide in the affairs of men, which taken at the flood, leads on to fortune. Omitted, all the voyage of their life is bound in shallows and in miseries. On such a full sea are we now afloat. And we must take the current when it serves, or lose our ventures." William Shakespeare
I don't typically make public recommendations for a stock purchase. In fact, my colleague and I have always been rather clandestine with respect to our investment practice. But once in a while there are game-changing investments you can make in the market. This is one of them and we feel compelled to share this, especially in light of all the pessimism surrounding nuclear. On that note, I recommend buying shares of Ur-Energy (URG) at the current price levels. This is an investment grade stock that should provide considerable protection and upside.
It is one of the safest, high-return operations on our radar at the moment. The idea that you win big by taking big risks doesn't work in the stock market. There are some more good ideas in this sector and I look forward to running a comparison article in the future. Denison Mines (DNN) is high on the radar, but I'll save that for another day.
Why invest in URG?
Firstly, I'm not a broker and thus have no desire to promote this stock for self-benefit. My goal is to provide sound investment advice to any reader looking for ideas. I will outline my investment thesis and then expound on each facet in detail. I have been following the Uranium Industry for several years and have reached the following conclusions with respect to Ur-Energy:
- Moderate risk
- Considerable upside
- Nice time to buy
- Excellent management team
- Improving financial position for the business
- Favorable long-term prospects
On March 11, 2011 a massive earthquake and tsunami struck Japan. This represented the biggest natural emergency for Japan since industrialization. The events of that day were apocalyptic:
- The earthquake generated a 15-meter tsunami that disabled the power supply and cooling of three Fukushima Daiichi reactors. All three cores melted in the first three days.
- The accident was rated 7 on the INES scale, due to high radioactive releases over days 4 to 6, eventually a total of some 940 PBq (I-131 eq).
- Four reactors are written off - 2719 MWe net.
- After two weeks the three reactors (units 1-3) were stable with water addition but no proper heat sink for removal of decay heat from fuel. By July they were being cooled with recycled water from the new treatment plant. Reactor temperatures had fallen to below 80ºC at the end of October, and official 'cold shutdown condition' was announced in mid-December.
- Apart from cooling, the basic ongoing task was to prevent release of radioactive materials, particularly in contaminated water leaked from the three units.
- There have been no deaths or cases of radiation sickness from the nuclear accident, but over 100,000 people had to be evacuated from their homes to ensure this. Government nervousness delays their return. Our thoughts and prayers remain with those affected.
Almost in an instant, Nuclear Power went from a booming industry to one of controversy. As expected, Mr. Market, Graham's fictional characterization of the stock market, lost complete control and uranium stocks got punished in the ensuing sell-off. That's when I decided to take a look. Consider this quote from a 1990 Berkshire Hathaway Shareholder address:
"The most common cause of low prices is pessimism-sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It's optimism that is the enemy of the rational buyer."
Mr. Buffett, we like doing business in such an environment as well. Buffett wasn't suggesting that investing in that context automatically makes you the smart guy. The point is you have to think for yourself and be rational when everyone gets emotional. In our post-Fukushima reality, Uranium stocks have faded into obscurity. These once high-flyers are still selling at panic levels despite having favorable future prospects. The truth is Nuclear Power remains one of the safest means of base load power production and it's not going anywhere. I will provide more support later, but here are some facts;
- There are currently 489 nuclear energy reactors planned or proposed globally, seven more than prior to Fukushima, and this is expected to drive a large increase in uranium demand [in the] mid- to long-term
- 80 new nuclear power reactors are on target to be commissioned by 2017, with 63 currently under construction. Planned and proposed reactors include 171 in China, 56 in India, 41 in Russia, 30 in the US and 13 in the Ukraine.
- Demand for uranium is expected to increase from around 166-million pounds a year to 226-million pounds a year by 2020, and to 280-million pounds a year by 2030. This compared with global mine supply of 139-million pounds in 2013, represents a significant gap for new mine supply to fill.
- Japan, Sweden, and Germany have idled their reactors but new reactors coming online will more than offset this drop in the next decade. We are likely to see some Japanese restarts next year. Heavy reliance on oil and gas imports is undermining their economic competitiveness.
There are always corrective forces at work in a market; the clouds covering this industry will ultimately give way to a bright sun or natural nuclear reactor if you prefer. In my view, the only downside is another Fukushima-like event. I'm willing to accept that as my investment risk given the safe track record of nuclear power.
Ur-Energy closed at $1.13 last week. According to the 3rd Quarter MDA, fully diluted shares outstanding are 137.49M. Add another 7.1M shares to account for the private placement deal just announced and you get 144.59M. You can buy this company for the price of three Gulfstream G550 jets or $163.4M. Pre-Fukushima, URG sold for as high as $3.27 or $447.9M outright- almost three times the current price when they basically just owned some land. The company is in a much stronger position today as it evolved from developer to producer and stands on the precipice of profitability. They delivered their first shipment of yellowcake to a plant in Illinois this past week. No one seems to have taken notice of this fact. More importantly, the business is deeply discounted to intrinsic value.
Assuming we hold off on the aircraft and buy URG, what are we getting for our money?
URG Share (lbs)
Lost Creek Property
Lost Creek Property
Lost Creek East
Lost Creek Property
Lost Creek East
Lost Creek Property
Lost Creek East
Lost Creek North
Lost Creek South
Lost Creek West
Balance Sheet Analysis:
|Mineral Reserves - Declared||$52,320,157|
|Mineral Reserves - Market||?|
|Deferred Financing Costs||$5,747,835|
|Total Asset Value||$112,286,742|
|Net Asset Value||60,728,782|
|URG Stock Price||$1.13|
|URG Shares Outstanding||144,000,000|
|URG Market Price||$162,720,000|
|Price/Net Asset Value**||$2.68|
|Net Asset Value/Share||$0.42|
This is what we get:
- $52.3M in mineral reserves or close to 21M lbs of U308 (measured + inferred). This does not include the pending acquisition of Pathfinder
- $6.2M in cash
- $5.2M in restricted cash
- $38.5M in buildings, machinery, equipment, and IT infrastructure
Throwing in the remaining assets gives us a total asset value of $112.2M. Subtract total debt and we're left with a net asset value of $60.7M or $.42/share. Since we're buying it for $1.13/share, on paper it looks like we're buying URG at a premium to NAV. There is a glitch in the matrix on Ur-Energy's balance sheet. The $52M recorded for their mineral assets is the acquisition cost for the properties (see note 6 in the 2012 40F). The economic reality is far different. Lost Creek is no longer just uranium in the ground, but a cash-generating project; a DCF model is required to determine the market value. According to Haywood Securities, NAV for the Lost Creek Uranium Project is around $181M. I'm working on a DCF Valuation and will post it in a future article when I'm done.
True NAV for the entire business is close to $200M. So in reality, we're buying URG for about .50 cents on a dollar. URG is flying under the radar and buying shares at the current price should minimize the downside if the market turns for the worse.
On the income side, I like the growth potential and earnings visibility. The business has secured long-term contracts for about 30-50% of its total production at an estimated $55/lbs of U308. They will most likely seek additional long-term contracts or sell the remaining yellowcake in the spot-market(@$34.75 on December 11, 2013). UR-Energy 3rd Qtr. MDA:
"The company has secured six uranium sales agreements related to production from Lost Creek spanning 2013 - 2019, including the first of Lost Creek's later term agreements, announced by the company in early July 2013. These long-term contracts call for deliveries over multi-year periods at defined prices."
Here's a brief article covering URG's first shipment of yellowcake in the Wyoming Business Report.
All things being equal, a business selling for fifty cents on a dollar naturally has more upside potential than one selling at par value. But a company can remain undervalued for years, tying up precious capital that could have been allocated elsewhere. So what will trigger a correction in the market price? As I explained earlier, URG has evolved from a developer to a producer. Look to Ur-Energy to report their first profit next year and earnings move stock prices. They leverage in situ recovery technology to minimize production costs and lower their onsite footprint. This comment from CEO Wayne Heili says it all, "These current levels do incentivize us to produce," he added: "We're lower than we'd like them to be, but they're not too low."
The point being they can make money in any market. That's my kind of business.
Solid Management Team
Wayne Heili assumed command of UR-Energy in May, 2011 and did not disappoint-he coordinated the company's transition from a developer to producer. This is no simple chore given the potential for unexpected problems that could lead to production delays, lower than desired production, or slower ramp up. 3rd Qtr. MDA:
"As at October 24, 2013, all production circuits of the plant were commissioned and uranium yellowcake had been processed, dried and packaged. Production rates during the period, from three header houses in Mine Unit 1, were exceeding projected levels. Additional header houses will be brought online when needed to sustain the targeted production rate."
I haven't met Mr. Heili or anyone on URG's management team, but I do know this. Execution is everything and in this case it was flawless. If there was a major weakness, it would have surfaced during the transition period. Good managers do the basic things well. They keep everyone focused on the mission and run the day-to-day operations as efficiently as possible. This may sound simplistic, but execution on this scale is harder than it looks. The company is now in a position to exploit any improvements in the uranium market; only 30 to 50% of current production capacity is under contract, leaving the remaining 50% available to be sold in a stronger price environment.
We are dealing with capable, seasoned managers that can be counted on to act responsibly and in the best interest of the shareholders. Investors need only be patient, giving them time to execute the project pipeline. I'm confident that Heili will continue steering the business in the right direction.
More on CEO Heili:
Nice Time to Buy
"The phenomenon that provides the greatest reward in relation to the risk involved- is the dramatic improvement in price that results from the combined effect of both a steady improvement in per-share earnings and a sharp, simultaneous increase in the price-earnings ratio. As the financial community quite correctly discovers that the fundamentals of the company (now its new image) have much more investment worth…" Phillip Fisher
Improvements in earnings per share will undoubtedly move stock prices, but Fisher observed another x-factor behind price movement. When the market recognizes the improving fundamentals for a company's industry it recalibrates the price-earnings ratio-the company is considered to have greater intrinsic quality, justifying a higher stock price. Fisher recommends that we factor the financial appraisal of the business into our analysis. It is his view that strong-businesses (ones having considerable investment merit), who's industry has fallen out of favor, carry the least investment risk and are most suitable for wise investment (Common Stocks and Uncommon Profits, p.210).
The uranium market will not stay depressed forever. If you buy URG now, you will no doubt benefit from the more immediate catalyst of improved earnings for the company, but perhaps even more so from a gradual reappraisal of uranium stocks when the industry recovers. Again, I remind investors to be patient. It will take time for any positive changes to be accepted, especially given the politicization of Fukushima. But that just gives us more time to buy.
Improving Financial Position for URG
Financial position: a concern's ability to have and to create liquidity (either from surplus cash or from other assets readily convertible into cash, such as a portfolio of blue-chip corporate stocks and bonds whose resale is not restricted); by an ability to generate surplus cash from operations; by an ability to borrow; or by an ability to market new issues of equity securities. Martin J. Whitman
This past summer was a tough one for Roger L. Smith, Ur-Energy's CFO. Smith, a seven-year veteran of the company and former Rio Tinto exec, had to keep the ship afloat while the business waited to close on the Sweetwater County, State of Wyoming, Taxable Industrial Development Revenue Bond ("State Bond Loan") for U.S. $34M. The approval process is rather drawn out and URG had nearly exhausted its working capital as it wrapped up construction at Lost Creek. He secured two high-interest loans from RMB Australia Holdings Ltd. (RMBAH) in the interim to finance the remaining construction costs and production began on schedule. URG closed on the State Bond Loan in October which was immediately used to pay off the RMBAH debt. The company released the following statement on October 24th:
"The closing of the State Bond Loan permitted the retirement of the company's debts with RMB Australia Holdings Ltd. ("RMBAH"). The two RMBAH loan facilities served as interim financing to complete construction at Lost Creek and begin production uninterrupted while the State Bond Loan was advanced to closing. The early repayment of the second loan facility triggered a rebate of half of the arrangement fee paid by the company ($450,000 credited) while half of the warrants issued in relation to that loan were also cancelled (1,500,400 warrants for common shares cancelled). A portion of the RMBAH first loan facility remains available to the company to be redrawn for specified purposes."
The State Bond Loan terms are much friendlier, calling for quarterly interest payments of 5.57% per annum beginning January 1, 2014. Quarterly principal payments commence on January 1, 2015 with the loan maturing in October 2021. The loan is secured by the Lost Creek Property assets.
In July the company executed a Share Purchase Agreement to acquire the Pathfinder Mines Corporation (Pathfinder) for $13.3M. The deal was just revised, dropping the capex requirement down to $5.3M. If Pathfinder has anything close to the estimated 15M lbs of U308 reported, that was a brilliant purchase. The caveat is that URG didn't have the cash to close the deal; now they are much closer. The bottom line is that the State Bond Loan eliminated the immediate liquidity risk. Going forward, the business will be in a position to employ a mixture of cash-flow from operations, debt, and equity to further exploit Lost Creek and breathe life into its Pathfinder property.
Much more could be said about UR-Energy's financial position, but I'm saving that for a more focused discussion of the financial statements in a follow on article.
Favorable Future Prospects
China is the fastest growing nuclear player in the world and this will profoundly impact the future of nuclear power. They need nuclear to satisfy a voracious appetite for energy but there are also signs China wants to establish itself as a credible overseas partner for nations seeking to revitalize or expand their civil nuclear programs. Through its partnership with French utility powerhouse, EDF, the Chinese are now major investors in the Hinkley C project (England's first new nuclear power station since 1995). Chancellor Osborne announced that the UK will allow Chinese companies to take a stake in British nuclear power plants, which have traditionally been funded by the taxpayer. Beijing also has a reactor deal on the table to supply Pakistan with two more nuclear reactors, worth some $9 billion.
Another interesting development is the emergence of entirely new reactor designs. We need to de-carbonize energy production and nuclear power should be the go-to technology. While nuclear power plants are ultra-efficient to run, be prepared to write a big check if you want to build one. Ask Buzz Miller, the executive vice president of nuclear development for Southern Company. The price tag for Vogtle 3 and 4 has risen to $4.8 billion. One potential game-changing technology that could lower costs is a Molten Salt Reactor. As the name implies it uses molten salt instead of water for cooling. Gareth Cook profiled the technology on New Yorker online:
"It's based on a method that worked successfully at the Oak Ridge National Laboratory, in Tennessee, in the nineteen-sixties. Called a molten salt reactor, it eschews rods and, instead, dissolves the nuclear fuel in a salt mixture, which is pumped in a loop with a reactor vessel at one end and a heat exchanger at the other. In the vessel, the fuel enters a critical state, heating up the salt, which then moves on to the heat exchanger, where it cools; it then travels back to the vessel, where it heats up again. Heat from the exchanger is used to make steam, and, from this, electricity. At the bottom of the reactor vessel is a drain pipe plugged with solid salt, maintained using a powerful electric cooler. If the cooler is turned off, or if it loses power, the plug melts and all of the molten salt containing the fuel drains to a storage area, where it cools on its own. There's no threat of a meltdown."
The point is nuclear power didn't die with Fukushima. It remains a dynamic industry and we are likely to see innovations in plant design that will make it even safer and more competitive with natural gas and coal. China's leading the way:
- Mainland China has 17 nuclear power reactors in operation, 30 under construction, and more about to start construction.
- Additional reactors are planned, including some of the world's most advanced, to give a four-fold increase in nuclear capacity to at least 58 GWe by 2020, then possibly 200 GWe by 2030, and 400 GWe by 2050.
- China has become largely self-sufficient in reactor design and construction, as well as other aspects of the fuel cycle, but is making full use of western technology while adapting and improving it.
- China's policy is for closed fuel cycle.
Much has been said about the expiration of the Russia-U.S. HEU "Megatons to Megawatts" program. It means that 24 million pounds of secondary supply is coming offline without any replacement-this is equivalent to the entire production of Cameco Corp. (CCJ) It's not clear where the new supply will come from but many believe a uranium supply crisis is brewing. According to David Talbot, senior mining analyst at Dundee Capital Markets, the weak spot price still threatens future mine supply with more closures, cancellations and deferrals of mining projects. He believes the fundamentals support much higher prices, but Japanese restarts are needed to provide a psychological boost for the industry.
Grant Isaac, Cameco Senior Vice President, gave an excellent presentation on the uranium market at the 2013 Scotia Bank Mining Conference. The transcript is available on Seeking Alpha and I strongly suggest reading it if you are seriously considering any investments in this sector. He said that the uranium market is in a transition period from being supply-driven to demand-driven. In past years, an abundance of secondary supply (i.e. HEU program) always tempered the price levels of uranium. With supply declining against a backdrop of low production, it leaves the impression that a perfect storm is in the works for uranium.
If the long-term fundamentals are so strong why are current prices so low?
No one's buying yet for all the reactors under construction and the utilities are well covered for the time being. They are in 'wait and see' mode due to the large inventory buildup in Japan and general uncertainty on the supply side. Ultimately, the utilities will return to the market. When they do, spot prices will recover.
Is Ur-Energy a wonderful business that will grow forever? Not quite, but it has considerable investment merit at the current price. This is a junior mining company with exceptional management; they execute the project plan with professionalism and run a very lean business. In fact, this operating efficiency is central to the brand and makes them competitive in almost any market.
You should never get emotional about a stock. Your desire to purchase a business should only be driven by the fundamentals and never by what the Street thinks. The market should never force your hand-you can take strikes all day long if you like, swinging only when the odds are truly in your favor. Value Investing is for the disciplined and patient few with the courage to think and act independently.