Things are not always what they seem. Market volatility is not necessarily a read on investor sentiment, and recent media excitement over the promise of nuclear program restarts in Japan and China does not mean the world is a better place for nuclear equities, at least not yet. As the media attention, is waning so is the performance of many nuclear energy stocks.
Delays in nuclear construction starts, weaker global nuclear power demand and unexciting near-term earnings outlooks, combined with broader market volatility and investor anxiety are putting considerable downside pressure on nuclear equities. Over the past several months, the nuclear energy stocks have strongly underperformed the broader market. In the last three months, the Global X Uranium ETF (URA) has lost -10%, and the Nuclear Energy ETF (NLR) (excluding the contribution from the soon to be acquired SHAW Group) lost nearly -4%, with both ETFs hovering near lows for the year. At the same time, the S&P is charging ahead, with just a few points away from its new high for the year. We have repeatedly warned about downside pressure for nuclear energy stocks (here and here) and continue to believe that a cautious stance is warranted.
Investors should be careful not to be lured by the cheap valuations alone. At this stage, lower valuations rightfully reflect higher required risk premiums, given poor near-term visibility and significant risk factors facing the nuclear industry. In our view, inexpensive valuations are rarely enough to drive investments. Improving business fundamentals - that is, the industry growth expectations - are also needed to drive investment decisions. Without improving fundamentals, the odds of continued slide in valuations are far from being trivial. Here are some of the reasons why:
- Much-awaited resumption of nuclear construction in China is yet to materialize. On May 31, 2012, China's State Council announced that it had, in principal, approved the nuclear safety plan. Shortly after this, Deputy Chair of the National Development and Reform Committee, Zhang Guobao, indicated that China is getting ready to start the construction of the four pre-approved nuclear plants. Yet one of the most important catalysts - the long-term nuclear development target and broader scale nuclear resumption of new projects - has not been confirmed. Further delay in new project approval may dampen investor sentiment even more.
- Restart of reactors in Japan may take significantly longer than was expected earlier. In September 2011, WNA estimated that by the end of 2012, Japan would return to nearly half of its nuclear generating capacity. With only 2 reactors currently operating (4% of installed capacity), we are far away from that level, and visibility on further restarts is anything but clear. Market repercussions of the delayed restart should not be underestimated. Each month of delays in Japanese nuclear restarts reduces global nuclear generation capacity and corresponding uranium requirements by about 1% from its pre-Fukushima level, or just over 11% annually.
- Uranium price weakness continues to be a drag on uranium mining sector, reflecting near-term oversupply. WNA estimates that 2011 global uranium requirements have declined by nearly 9%, while, in our estimate, total supply increased (albeit modestly). This dynamic remains intact for 2012: uranium requirements still lag pre-Fukushima levels, however, near-term production and secondary supplies have not kept the same pace. In recent weeks, some of the largest uranium producers, including Kazatomprom, Cameco (CCJ), Uranium One and Paladin, confirmed flat or higher production levels for 2012. At the same time, the U.S. Department of Energy announced increased amount of uranium inventory sales for 2012 and 2013. And while delays at BHP Billiton's (BHP) Olympic Dam and Cameco's Kintyre may signal uranium shortage in the longer term, near-term realities are more challenging. In fact, UxC now estimates that further price incentives might be needed to encourage near-term spot demand.
- Weaker earnings expected for 2012 as investors, analysts and companies are ratcheting down their expectations following a slew of disappointing earnings and cloudy 2013 outlook. While reducing expectations is a healthy trend in the current environment, helping to bring previously unreasonably high expectations closer to economic realities of the nuclear energy sector, the process adds sizable volatility along the way.
Yet it is not all doom and gloom in the world of nuclear investing. Over the long-term, the nuclear industry is still expected to have a solid growth, mainly driven by nuclear expansion in the emerging economies. In addition, forward calendar also offers a few reasons for optimism:
- Sooner or later China is likely to march forward with its nuclear expansion program. Resumption of nuclear orders should strongly improve the sentiment. However, investors may have to wait until China's government transition takes effect later this year.
- China National Nuclear Power (CNNP) IPO currently planned for October is expected to be the largest-ever listing in China, with a $27Bn capital raise. The IPO is likely to add a spotlight on the industry overall and can help revive investor interest in the sector.
- Uranium purchasing activity usually picks up closer to the end of 3Q/4Q, which may stimulate uranium price and corresponding share performance of publicly traded uranium mining companies.
- HEU program expiration at the end of 2013 likely to be viewed as a strong positive catalyst, as it removes roughly 24 million pounds per year of natural uranium equivalent from the annual supply. This view is only partially correct: 1) expiration of the agreement has been widely anticipated for some time and should be priced in by now; 2) a large share of the HEU supply will be replaced by primary production increases from Kazakhstan, Canada (Cigar Lake) and other sources. The main positive comes from the fact that the uranium industry would have smaller share supplied by less economically sensitive government inventories.
The catalysts above can deliver a breath a fresh air into the battered sector. Meanwhile, the near-term challenges continue to overshadow long-term fundamentals for the nuclear energy sector. Investors should remain cautious and watch for a change in the conditions above as potential catalysts for the nuclear market.