First, with regards to the uranium market, anyone who believes that this major supply crunch is going to be solved over the near term should have a read through URRE’s annual report in order to understand the ridiculous red tape that goes into uranium mine permitting. Uranium mines take an incredibly long time to develop because of the environmental permitting and the public’s extreme aversion to nuclear power. As much as anything else, bureaucracy will keep the uranium price high. This holds across all developed countries, which is what led Paladin to forgo opportunities in Australia in favor of Africa. Given that most of the world’s known uranium reserves are in Australia and Canada, red tape is not going away. (Incidentally, this is one of the reasons I like NWTMF as a speculative explorer, because Niger is politically friendly to uranium mining).
Now, on to URRE. I have been negative about this company in the past due largely to short-term production failures, but after reviewing the company’s most recent Annual Report with a more long-term outlook, I believe that some of my previous comments represented a bit of short-termism. There are some very compelling reasons to be a URRE shareholder, and I have recently reversed my stance on this company and entered into a position here.
First, I am going to create some estimates on production and earnings for 2007. According to the 10K, URRE expects to produce about 100k pounds of uranium in the first quarter. Of this 100k pounds, about 45k will come from the company’s new well in Kingsville Dome that was opened in January. The company expects to bring online another well during the 2nd quarter and a third well during the third quarter. Assuming that these wells produce add about 40k pounds of uranium production per quarter and that the company’s Vasquez production is shut down after producing 100k pounds for the year (as planned and stated in the 10K), total production for the year should be in the neighborhood of 480k pounds. This production figure does not account for the potential development of the company’s Rosita property in Texas, which is currently being redeveloped and may be brought back online by the end of 2007.
Making the conservative assumption that the uranium price will average $100/lb in 2007, URRE’s sales price should average about $70-$75 per pound for the year. Therefore, if we assume 480k pounds of production and an average selling price of $70/lb, URRE is looking at 2007 revenues of about $34 million. However, production costs should decline significantly due to the impact of the more prolific new wells brought online, and I estimate that production costs will be approximately $30/lb (consistent with URRE’s historical costs before 2006). Therefore, we are looking at a gross profit of about $19 million for the year, and assuming G&A expenses will increase to about $9 million (to account for expected increases in legal costs related to New Mexico development), Net income is likely to be about $10 million and EPS approximately 19 cents per share. Based on 2007 expected earnings, URRE isn’t cheap, but the valuation is certainly not out of line with other uranium producers. In addition, URRE has no debt and $20 million in cash in the bank, so their balance sheet is better than most other near term uranium producers. This strong balance sheet and positive cash flow for the year should significantly decrease the need for financing, so further dilution appears to be unlikely here.
However, the real value of this company lies in the companies asset base. According to independent analysis, URRE’s New Mexico properties contain over 91 million pounds of uranium, and although there are no official estimates for the Texas properties, it appears that Kingsville Dome and Rosita probably add about 5-10 million pounds of uranium to this total. Now, it is worth noting that not all of these reserves will are likely to be recoverable, and part of the company’s New Mexico property is in dispute with the Navajo nation over mining rights. However, even if we throw out the entire Churchrock property (18.6 million pounds of estimated uranium) that is under dispute with the Navajo nation and then assume that only two-thirds of the company’s estimated reserves are recoverable, the company still has about 48 million pounds of reserves in New Mexico. By adding in 5 million pounds in Texas reserves, I estimate that URRE has a minimum of about 53 million pounds of recoverable reserves on its properties.
This asset base is very significant indeed, and is being significantly discounted as compared to other near-term uranium producers. For instance, Paladin resources recently paid $1.1 billion to acquire Summit Resources, and Summit had reserves of approximately 40 million pounds and was not yet producing on any of its properties. This implies that URRE could fetch a similar value in a potential takeover, and yet its shares are trading at a market capitalization of just over $500 million dollars.
On a net present value basis, URRE’s valuation appears to be even more heavily discounted. If we conservatively assume that the long term uranium price will be $80 per pound , the total lifetime revenue provided by URRE’s assets would be $42 billion. Assuming a long term net margin of 30% (which I believe to be easily achievable given production costs of $30/lb), the total earnings provided by URRE’s assets would be about $12.5 billion. Assuming a 25 year development timeline for these assets and a risk-free interest rate of 6.5%, the net present value of URRE’s future earnings would be approximately $2.6 billion dollars. That represents a significant premium over the current market capitalization.
Obviously, URRE’s current market capitalization is being weighed on by production shortfalls in 2006 and continued uncertainty surrounding the legal status of some of the company’s New Mexico holdings. However, while the legal issues remain a factor going forward, they only affect a portion of URRE’s very large New Mexico holdings. Moreover, URRE’s production shortfalls in 2006 are in the process of being fixed by bringing new wells into production in the Kingsville Dome project and by phasing out the company’s mining operations on the high-cost Vasquez property.
Overall, despite the recent rise in URRE’s stock price, I believe that the company has yet to reach a full market valuation. The lack of visibility of this company when it was being traded on the Bulletin Board means that it was neglected for quite a long time, but with the company’s recent listing on the Nasdaq, URRE is unlikely to go unnoticed much longer. Whether it will be through an acquisition or through organic growth, URRE’s stock price appears poised to head higher.
Disclosure: I am long URRE.