We have been poking around Mega Uranium (MGAFF.PK) for the last couple of months to see if the price decline following Fukushima has created a buying opportunity or simply left the company dead in the water. What we’ve found is rather emblematic of the paradox facing the uranium mining industry in this post-Fukushima world.
Mega Uranium has two primary projects: Lake Maitland in Western Australia and Ben Lomond in Queensland. Until Fukushima, Mega Uranium had been developing Lake Maitland towards becoming a new uranium mine, with a start date we realistically estimate was probably in 2014. Ben Lomond was a project on hold due to the incumbent government in Queensland having a ban against uranium mining.
In this post-Fukushima world, uranium is trading for a spot price below $55/lb and a long term price below $65/lb. At these price levels, we have not found many projects except for Roughrider in the Athabasca Basin that make economic sense. Our research indicates that the CAPEX and operating costs involved at Lake Maitland are probably going to be approximately $200 million and A$50/lb, and we don’t see a uranium mine with those economics attracting capital without a long term uranium price above $75/lb.
We spoke with Investor Relations at Mega Uranium, and they were very up front with us that in the current pricing environment it does not make sense to develop Lake Maitland. The company is basically waiting for the uranium price to recover with an eye on the projected supply deficit that will worsen in the next couple of years. The company did tell us that they figure that they will need 18 months to get Lake Maitland up and running from the day of a production decision which they repeatedly pointed out was a very quick development timeline. The messaging we were getting here was “once the uranium price comes back, we will be one of the first new mines on the market and thus benefit from it versus several other junior uranium companies”.
We have internally assigned Lake Maitland a value of $13.46 million based on Mega Uranium’s 65% interest in the project and a $1/lb. indicated resource of U3O8 which is in line with how we are valuing other uranium resources not in the Athabasca Basin that have had their economics destroyed in the aftermath of the tsunami and resulting uranium price decline.
Once the feasibility study is completed and a decision to proceed is made, the joint venture partner will have to make payments equaling $39.7 million to Mega Uranium and cover 35% of the mine development capital expenditure.
Having considered these things, we have to keep Lake Maitland on the back burner here due to current uranium prices. Let’s look at the company’s other major project in Australia, Ben Lomond in Queensland. Current polls indicate that the Labor government will convincingly lose the election scheduled for Spring 2012 (must be held in June at the latest). Given that the Liberal National party has indicated it supports uranium mining and lifting the ban, Ben Lomond merits serious investigation.
The current indicated resource at Ben Lomond consists of 7.9 million pounds U3O8 at an ore grade of 0.27%. Using our $1/lb. indicated U3O8 valuation for non-Athatbasca uranium deposits without a net present value model, we are assigning the project $7.9 million in value to Mega Uranium.
When we addressed this project with Investor Relations, we got the sense that they have been waiting for someone to ask them about it for awhile because they want to talk about it. Based on our conversation, the fact that there have been previous Definitive Feasibility Studies executed on the deposit, and the fact that this deposit was very close to becoming a mine back in the 1985 prior to the implantation of the “Three Uranium Mines Policy” when the price of uranium was approximately $20/lb., we are left to believe that the true flagship project in the Mega Uranium portfolio is in fact Ben Lomond. While we are not experts, we estimate that it would take 24-36 months to get Ben Lomond to producing status if Mega Uranium starts laying the foundation to start the process immediately after the next election. Having said that though, we are not going to assign any value right now to Ben Lomond beyond our $1/lb. indicated resource multiple.
Together, these two projects are worth $21.35 million to Mega Uranium. We project the company probably currently has $25 million in cash and corporate bonds (assuming $5 million spent since June 30th). We also assign $1.5 million in value for the capital assets listed on the balance sheet worth $2 million. With respect to the portfolio of investments in other junior uranium companies, we took Friday November 25th closing prices where available and assigned a 25% discount to come to a valuation of $6.22 million. Given the total liabilities of $10.71 million on the balance sheet as of June 30th, we see a rock bottom, worst case, disaster valuation on Mega Uranium of approximately $0.17/share. In simpler terms, we cannot envision a scenario where the stock trades through that level on a fundamental basis.
We are analyzing Mega Uranium through the lens of "rock bottom valuation" because in our eyes the junior uranium sector (with the exception of one company in the Athabasca Basin) is currently a call option on the resumption of the nuclear renaissance and not a new multi-year nuclear winter. Until the uranium price recovers, where Mega Uranium trades relative to this rock bottom valuation represents the value of the this implicit call option.
With the stock currently trading at $0.22/share, we are left intrigued by this company as a potential cheap call option on the recovery of uranium prices given what we are leaving on the table in our valuation. Perhaps the case can be made that we should assign a higher multiple on Lake Maitland and Ben Lomond given their short development timelines once a decision is made that uranium prices have recovered enough? If our multiple was $2/lb, we would have derived a basement valuation exceeding the current share price.
Perhaps we should assign some value to the payments due to Mega Uranium upon completion of the feasibility study and decision to proceed with Lake Maitland? If we put that decision to proceed in 2014, and discount back the payment at 20% for two and a half years, we get a net present value of $25 million, or approximately $0.09/share in additional value. If we assign some value to the Maureen deposit that Mega Uranium owns containing 5.95 million pounds of U3O8 at an indicated resource level, that would increase our "rock bottom" fundamental valuation to $0.19/share.
But here lies the dilemma we have; we can paint all that blue sky and say we are bottom fishing, but it does not change the reality here that this company needs uranium prices to increase dramatically over the next two years. We also have to wonder what sort of terms will Mega Uranium be able to get for project financing. After all, at the current market capitalization, a capital raise to fund development Lake Maitland would leave current shareholders with less than 40% of the post-financing share count. The scenario is practically laughable.
So here we stand as uranium bulls, very bullish on only one junior uranium miner (see our November 2011 issue of The Strategist Newsletter) but left wondering where the remainder of the value is in the sector. In many ways, the bidding war for Hathor Exploration (HTHXF.PK) has revived the spirits and share prices of Athabasca Basin companies, but reminded all of us that the junior uranium mining sector remains decimated.
In the face of all this analysis, and in the spirit of our search for market dislocations of long term fundamental value, we have to say that Mega Uranium - which we have been following for over a year - is not a buy at current levels.
If, however, the share price trades down through its 52 week low and into the $.17-$.18/share level, we will be buyers of this company as a very attractive risk-adjusted investment on the re-emergence of the uranium renaissance over the next 3-4 years. At those price levels, we calculate that we would be paying zero for the implicit call option of higher uranium prices and we would be getting shares at a discount to rock bottom valuation.
In terms of catalysts to be aware of:
1) We are tracking the polls in Queensland. As a National Liberal Party victory becomes more anticipated, we think a rally in Queensland uranium juniors can be expected.
2) Keep your eyes up for chatter from the Western Australia Labor Party about “no uranium mining” being in their party platform for the next election, which must take place in 2013. It is an obvious headwind for Mega Uranium but one that does not concern us severely. Based on the settlement Boss Uranium received for government interference on one of its projects (in British Columbia) and the Japanese joint venture partners, we think Mega Uranium would have a very persuasive legal argument for a significant cash payment from the Western Australian government should uranium mining be banned by an incoming Labor Party government.
Assuming that the only compensation was for development costs incurred, we estimate Mega Uranium would be entitled to a payment of approximately $30 million. We do not have knowledge of how this would be distributed with the other joint venture partners, but at the 65% interest Mega Uranium has in the project, such a payment would effectively just monetize Lake Maitland at a significant premium to the $13.46 million value we have assigned to Mega Uranium's interest in the project.
3) Uranium Price: Paladin Energy (PALAF.PK) at its annual general meeting made a very compelling presentation that uranium prices are not sustainable given long term supply-demand dynamics and the returns currently available on the development of new uranium projects (Lake Maitland in many ways is the poster child for this). We expect an increase in the price of uranium will result in a levered increased in the share price of Mega Uranium.
4) Diamond Drill Program Results: Mega Uranium is conducting a diamond drill program on Lake Maitland it believes will increase the ore grade at the project. If this turns out to be the case, we expect to see a rally to reflect the increase in value at Lake Maitland.
Until our buying range ($0.17-$0.18/share) is achieved though, there is only one uranium junior mining company we are comfortable owning and have shared with our newsletter subscribers. We feel very comfortable investing in Mega Uranium also given our research on the company and bullish macro view on uranium, but given the current market environment and time horizon on this potential investment, we want the built in call option on uranium prices for free. This is a sector that will merit serious discussion throughout 2012; we will be watching it carefully given our long term bullish view on uranium.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in MGAFF.PK over the next 72 hours.
Additional disclosure: The Editor of The Strategist Newsletter holds a position in Hathor Exploration; he has indicated he may sell in the next 72 hours.