Why Cameco Will Make A Comeback

| About: Cameco Corporation (CCJ)

Summary

Cameco enjoys protection against weak uranium spot pricing on the back of its long-term contracts that allow it to generate stronger pricing despite end-market weakness.

Last quarter, Cameco’s average realized price from long-term contracts was $42.91 per pound as compared to an average spot market price of $27.15 per pound.

Driven by the higher contract pricing, Cameco’s financials should pick up pace in the second half of the year as it anticipates strong growth in sales volumes.

Cameco is well-placed to benefit from an improvement in the demand-supply scenario of the uranium market as it is enhancing production from low-cost assets.

Uranium miner Cameco (NYSE:CCJ) shares are currently trading close to 52-week lows after beginning the year on a strong note. So far this year, Cameco shares are down almost 30%. The collapse in Cameco's performance on the market can be attributed to low uranium demand across the globe, which has hurt uranium prices due to oversupply. In fact, the spot and long-term uranium prices have plummeted to new 10-year lows, with the spot price falling nearly 30% in the past one year.

But, investors should note that despite the current market challenges, Cameco is witnessing better average realized prices under its long-term contract portfolio, which were approximately 60% higher than the average spot price for the second quarter. While this higher realized price from its long-term contract portfolio should help it do well in adverse circumstances, Cameco's aggressive cost reduction efforts across the business should improve its bottom line performance.

Moreover, an expected increase in demand for uranium in India, China, and Russia, along with Cameco's effort to accelerate production from lower cost mines, will lead to an improved financial performance in the long run. As such, in this article, we will take a closer look at the reasons why investors should continue holding Cameco shares.

Cameco is enjoying protection against weaker pricing

Cameco is expected to deliver 27 million pounds of uranium production per year, starting from 2016 through 2018. The company is ramping up production because it expects sales volumes to increase further between 2019 and 2020.

A key reason why Cameco is aggressive about ramping up production is because its average realized prices would be higher with the decrease in the spot price of uranium and vice versa. For example, its average realized price for its long-term contracts during the second quarter was at $42.91 per pound, compared to an average spot market price of $27.15 per pound. In fact, even if uranium spot prices fall to just $20 per pound, its average realized price will be at $41.00 per pound, protecting its revenue under a difficult market environment. The table below illustrates its average realize prices under various spot pricing scenario.

Click to enlarge

Source: Cameco Corporation

Why Cameco's sales will improve going forward

For the second half of 2016, Cameco's sales volumes are forecasted to come in the range of 20 million to 22 million pounds, generating revenue of close to $1 billion at the current average realized price in the uranium segment. This is higher than the revenue of $875 million that Cameco generated in the first half of the year. In fact, analysts expect the company to generate revenues of $507.44 million and $606.74 million in the third quarter and the fourth quarters, respectively.

In my view, Cameco will be able to generate higher revenue in the second half of the year because it is increasing production at lower cost, tier-one assets such as McArthur River/Key Lake, Cigar Lake, and Inkai. For instance, its uranium production during the second quarter at Cigar Lake, Inkai, and Rabbit Lake increased 67%, 87%, and 250%, respectively, as compared to 2015 levels. In fact, Cameco has installed a new calciner at these assets that will lead to incremental production.

This uptick in the uranium production from its tier-one assets suggests that Cameco is following the right strategy to meet an expected increase in uranium demand in the long run. According to UxC, global nuclear power capacity is estimated to grow by more than 44% to 540.6 gigawatts in 2030 from that of 376.6 gigawatts in 2015. This means that the capacity expansion will take place at a compounded annual growth rate of 2.51% from 2016 to 2030, which should drive uranium demand going forward.

On the flip side, the primary supply of uranium isn't expected to grow at the same pace as demand. For instance, global production plummeted by over 5.3 million pounds in 2015, representing a decline of 3.6% from 2014. Moreover, the primary production is expected to increase to just 168.7 million pounds by the end of 2025 from 151.3 million pounds in 2015.

Although this represents an absolute increase of approximately 11.5%, it is lower than the growth rate of uranium demand as stated above on an annual basis. As a result, Cameco's sales volumes will increase in the long run due to a deficit in supply.

Conclusion

Therefore, in my opinion, investors should focus on the long-term prospects of Cameco. The company's stock might have taken a beating of late, but the good news is that it is well-placed to benefit from an improvement in demand going forward. Cameco's higher realized prices than the industry are another reason why investors can expect a comeback in the second half of the year as sales are expected to pick up pace. So, in light of the points discussed above, investors should continue holding Cameco shares as the company can make a comeback.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.