Passing on Cameco: Cloudy Future, No Real Discount in Pricing

Jul.10.11 | About: Cameco Corporation (CCJ)

Once upon a time, uranium was dirt cheap, to the tune of roughly $10/lb. to be exact (funny, since $10 won’t even get us more than three gallons of gasoline today). Today, we face the exact opposite scenario, because uranium miners have continually failed to meet global demand. You don’t need to be a nuclear physicist to guess that the price of uranium has steadily increased over the last few decades. For Cameco Corp. (NYSE:CCJ), higher prices and increasing global demand should have led to “happily ever after,” but events in Japan might be changing the story ending.

The nuclear accident in Japan could materially impact Cameco, since nuclear-powered countries have been forced to reevaluate this energy source. In our view, Cameco isn’t trading at any real discount to compensate for the increased exposure to a potentially weakening uranium market. We feel Cameco’s future is far from certain and that investors should PASS on the firm.

A Radioactive Fiasco

The sad events at Japan’s Fukushima nuclear plant have knocked the wind out of the uranium rally that started in October 2010. While Cameco’s Q1 results may not reflect this to a significant degree, this isn’t something to overlook; the accident will likely affect Q2 2011 results. The firm has already reduced revenue-growth forecasts by approximately 5 percent to roughly 10-15 percent revenue growth.

Uranium prices in January and February 2011 averaged $71; now the price is around $55, a 29 percent drop, just based on the Japanese event. Germany, the most productive economy in Europe, has renounced the use of nuclear power in the future and plans to shut down its remaining nuclear facilities. China has halted construction of all new nuclear reactors until it reviews and re-inspects each site. Other nuclear-powered countries such as Russia, South Korea, and India have also, to a lesser degree, voiced concerns about the risks. We feel that current uranium prices haven’t sufficiently factored in the potential reduction in immediate/intermediate demand, and this does not bode well for CCJ.

Pricing With Amnesia

From a valuation standpoint, we don’t see CCJ trading at any substantial discount that would interest us. The firm appears to be fairly valued or perhaps slightly overvalued, and If one major nuclear-powered nation announces a reduction in its dependence on nuclear power, it could knock uranium prices and CCJ shares much lower.

Price Multiple Valuation CCJ Industry S&P/TSX

P/S Ratio

21.8 17.9 29.3

P/CFO Ratio

4.8 1.9 6.3

Forward P/E Ratio

15.5 N/A 14.6
Click to enlarge

We Won’t Set Sail With Columbus’ Step–Brother

The firm is entering uncharted waters with limited or no experience as it aims for greater vertical integration. While Christopher Columbus may have rediscovered the Western Hemisphere after Amerigo Vespucci, not all expeditions go so well. There is concern from some in the investment community, including us, that Cameco’s ambitions may lead it into a disastrous excursion.

This expansion is being driven by CCJ management’s desire to convert a materials company, into a uranium company, with full vertical integration. Mining uranium isn’t a walk in the park, combined with other headwinds, we feel that the firm could become overextended and fall on its face. This possibility can only increase as the firm enters new markets where it has limited or no expertise. If CCJ expands into new areas, without squarely addressing these concerns, it is a definite warning sign for investors.

Conclusion

Near-term uranium demand and pricing has been materially impacted by the Fukushima tragedy. There’s been a small domino effect, with the potential to get much bigger. Separately, the recent acquisition of Bruce Power has presented its own challenges. The desire for aggressive expansion doesn’t make us feel warm and cuddly inside. In our view, neither Cameco Corp. nor uranium are places with significant opportunity, given the cloudy future and no real discount in pricing. We realize that the stock has substantially retraced from 52-week highs, but the prior price of stock does not reflect the true (lower) value of the company in our opinion.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.