Seeking Alpha

The Energy Report's  Instablog

The Energy Report
Send Message
The Energy Report features leading investment coverage of fossil, nuclear, renewable and alternative energies. A Streetwise Reports publication. www.TheEnergyReport.com
My company:
The Energy Report
My blog:
The Energy Report
My book:
The Energy Report Newsletter
View The Energy Report's Instablogs on:
  • Joe Reagor: Four Uranium Companies Poised To Profit From The Growth Of Nuclear Power

    Nuclear power is enjoying a renaissance, and the world will soon need more uranium. Up to 50% more within a decade, says Joe Reagor of ROTH Capital. In this interview with The Mining Report, he explains that the share prices of uranium juniors remain low because the uranium spot price has not yet risen to reflect the increased demand just around the corner. This provides a great opportunity for canny, long-term investors, and Reagor identifies four companies that have the means to profit from the inevitable need for their product.

    The Mining Report: The 27th annual ROTH conference was held in California last month. What's the purpose of this conference?

    Joe Reagor: We provide management access to our client base and provide exposure for the smaller-cap companies that are somewhat under-covered by the Street.

    TMR: How would you sum up the sentiments of the participants?

    JR: In the mining sector, I heard a bit of cautious optimism. Conditions seem to be improving, but the strength of the U.S. dollar is not helping most commodity prices. However, if you operate outside of the U.S., margins are improving.

    TMR: With all the concern about a possible stock-market bubble, was there perhaps a feeling that miners may be due for a revaluation because they produce things of tangible worth?

    JR: There has been more generalist interest in mining recently because of the fear that the broader market is getting a bit frothy in certain sectors. This lends support for diversification and investment in mining companies because, as you said, they do produce hard assets and can benefit should the overall market underperform.

    TMR: Since we last spoke, the spot price of uranium topped $40/pound [$40/lb], and is now just above $39/lb. What are the fundamentals that have undergirded this rise?

    JR: There was a significant supply overhang after the Fukushima disaster of 2011. Then there were two large sales that occurred after that, probably inventory liquidation, perhaps from Japan. We reached the bottom last summer.

    The supply overhang peaked again due to increased production from Kazakhstan. But that is no longer a problem. Kazakh production is no longer growing, and some of the larger uranium projects globally have been put on hold. That has allowed the inventory level to return to normal levels and has enabled a more sustainable pricing point.

    TMR: Where do you see uranium going for the duration of 2015?

    JR: There will be additional demand as nuclear reactors come back on-line in Japan, and as China completes new ones. So, I think the price will continue to trend upward, perhaps to $50/lb by year-end, although we might continue to see small pullbacks.

    TMR: China's demand for new reactors is dependent on burgeoning economic growth. Will China continue to expand as it has in the recent past?

    JR: I'm not a macro expert on that subject, but my opinion is that China will continue to grow at a rate that will inspire envy in Europe and the U.S., but it will not be the double-digit growth we became accustomed to. China needs to produce more power for a growing and more affluent population, so it will need reactors. For that reason, I think China's uranium needs may grow faster than its economy overall.

    TMR: According to a report by Cameco Corp. [CCO:TSX; CCJ:NYSE], the amount of uranium required to service the growing number of nuclear reactors will increase from 155 million pounds [155 Mlb] annually today to 230 Mlb annually within a decade. Can this need be met?

    JR: There is some apprehension about whether uranium production can grow to that level. One source will be uranium as a mining byproduct. In the past, uranium produced by certain mines was treated as waste, but, if needed, this could enter the market.

    Multimillion-pound uranium projects in Canada and in the U.S. would likely see increased investment should uranium rise above $55/lb. And Kazakhstan can increase production significantly, even though it already produces one-third of world supply.

    TMR: Assuming that uranium demand does indeed rise to 230 Mlb annually, how would that affect the price?

    JR: In the short term, price spikes of up to $100/lb are possible. In the long term, we're looking at a price in the $60-70/lb range. The problem of price spikes could be solved with offtake agreements, whereby utilities help fund the development of uranium projects in return for contracts to buy uranium at fixed prices.

    TMR: Given the recent success of uranium exploration in Saskatchewan, will there be a rush to develop these projects should the uranium price top $55/lb?

    JR: Not necessarily. The uranium industry is now well aware of its supply-and-demand dynamics. A price above $55/lb will encourage additional development, but not of any projects that would result in significant oversupply. Most of the world's active uranium mines are very profitable at $55/lb.

    TMR: How finely can uranium demand be calibrated?

    JR: Current uranium demand is 155 Mlb, plus or minus 5%, assuming no additional reactors. Reactor lead time is up to five years, and that is more than enough time to source new supply.

    TMR: Can you explain how the price of uranium is determined by long-term contracts signed by utilities and what the current state of this process is?

    JR: Contract-price uranium has enjoyed a premium over spot price. This has trended down to only a couple of dollars a pound, but historically it has been closer to $10/lb. Utilities generally seek to sign contracts to buy uranium two years into the future. But they will sometimes take delivery 6 to 12 months early and have it sent to their concentrators. The ultimate purpose of these contracts for utilities is to provide price stability for energy consumers. And to the miners, these contracts guarantee financing.

    The great majority of uranium is sourced via contracts, with only 5-15% provided by the spot market.

    TMR: It has been suggested that the price of uranium is likely to increase soon because several large 7 to 10 year contracts are coming to an end. Do you agree?

    JR: Some larger producers, such as Cameco or AREVA SA [AREVA:EPA], have contracts with utilities coming up for renewal. There is a essentially a quoted contract price out there that's well known and then an assumed inflationary rate beyond that. I think the utilities are likely to simply renew these contacts with their existing producers. The bigger concern is that the Japanese utilities have not renewed contracts and don't have offtake agreements, so they might be forced into the spot market.

    TMR: We often hear the uranium market compared to a game of chicken between suppliers and utilities. Is this a useful metaphor?

    JR: It's a bit overstated. Suppliers use this comparison in order to suggest that the price of uranium is going to increase, but when we compare in importance the overall cost of running a nuclear power plant versus the cost of 500,000 lb [500 Klb] to 1 Mlb of uranium, the latter is not all that crucial.

    Utilities are not that incentivized to haggle over a few dollars a pound, as the suppliers would have you believe. Utilities can now make up any supply shortfalls from their contracts in the open market, and that could lead to a tighter spot market.

    TMR: Would you talk about mergers in the industry?

    JR: It's been three months since the merger of Energy Fuels Inc. (OTC:UUUU) and Uranerz Energy Corp. (NYSEMKT:URZ) was announced. The deal is transformational in that it creates multiple avenues of producing returns for shareholders. Energy Fuels had been a conventional uranium miner and producer. Adding Uranerz will give it an in-situ recovery [ISR] method of production and therefore the flexibility to fluctuate between the two methods as needed. ISR also provides a low-cost option should the uranium price flatten or trend downward. And the merger also provides the new company with additional cash flow to reinvest into larger uranium conventional projects should the uranium price reach the $55-60/lb range.

    TMR: You recently noted that revised growth plans for the new company will not be available until the merger is complete. Are there any clues as to what those plans might be?

    JR: U.S. companies are prohibited from providing such guidance. I'm sure Energy Fuels would prefer to provide it to shareholders and analysts, but it can't.

    TMR: In your March 23 research report, you wrote, "Q4/14 was a poor quarter for [Energy Fuels], as the company made no significant uranium sales. . .we anticipate a similar sales schedule in 2015 to that of 2014, with [the company] producing only 70 Klb of uranium and drawing down inventories to meet contract sales volumes of 800 Klb." Is this model sustainable?

    JR: Well, Energy Fuels has contracts beyond this year. I believe the contracts do get a little smaller as we go out, but Energy Fuel's goal is to produce only from its conventional mining methods what it needs to deliver into those contracts. Should the uranium spot price rise above $50/lb, Energy Fuels would be able to increase production.

    On the other hand, should the spot price remain flat, we'd expect the company to produce just enough to meet contracts, with perhaps a slight amount beyond that to provide a cushion. The 75 Klb is just it finishing up the Pinenut mine in Arizona. Next year, Energy Fuels will switch to its Canyon mine in Arizona, which is expected to produce the 700 Klb it will need for next year's deliveries.

    TMR: How does Canyon compare to Pinenut with regard to costs? And are there significant costs associated with switching production from Pinenut to Canyon?

    JR: We won't know the cost metrics until Canyon actually begins production, but I expect them to be similar. There's going to be a development cost for Canyon, probably $10-20 million [$10-20M], but the good news is that the Pinenut workforce is being transferred to Canyon, so there will be no significant severance costs.

    TMR: Around the middle of February, Energy Fuels' shares were trading around $6.50 but then fell to $5.03 by the beginning of April. They've since recovered to $5.26/share. Did the share-price fall surprise you?

    JR: I've been a bit surprised in general by the underperformance of the small-cap uranium producers in the face of the steady flow of positive news regarding the uranium price. This provides an opportunity to investors, in my opinion.

    We're maintaining a Buy rating and an $11 target price for Energy Fuels until we get further guidance. My overall view is that the Uranerz acquisition will result in a stronger, better company. Its current valuation is based solely on Energy Fuels, so there is upside for the combined company, even though reworking the numbers may or may not result in a higher valuation after the fact.

    TMR: How does Uranerz make the new company better?

    JR: By providing a lower-cost production footprint. Nichols Ranch will be an ISR producer and is expected to have significantly lower operating costs than those of conventional mines such as Canyon. Uranerz is also bringing some contracts that Energy Fuels can deliver into. Plus, Uranerz's additional ISR projects give Energy Fuels additional future production flexibility.

    TMR: How important is flexibility in today's uranium market?

    JR: Given the potential for price shocks, up or down, having flexibility in its production schedule and investment decisions is a significant differentiator for Energy Fuels. It stands apart from the other uranium juniors that have solely conventional or ISR production.

    TMR: So ISR capability allows the new company to move more quickly based on possible spikes?

    JR: ISR can reach production faster but cannot reach the same magnitude. ISR also allows fluctuation of production flow rates without significantly altering production costs. With conventional mines, production fluctuations can significantly alter operating-cost metrics.

    The advantage of conventional mines is that they are more scalable. So one would expect a shift to conventional mining should we see a big increase in the uranium price.

    TMR: What other junior you follow has seen a significant drop in its share price?

    JR: Uranium Resources Inc. (NASDAQ:URRE) fell from above $1.80 in March to $1.27.

    TMR: Why did that happen?

    JR: First, the company raised additional capital necessary to continue to fund development of its assets, and the additional dilution forced the valuation down. That offset the uptick in the uranium spot price.

    Second, Uranium Resources provided an update on its pounds in the ground resources and reserves, which showed some larger than expected reductions at certain properties. When the company made a land swap agreement on Roca Honda, it didn't provide the exact details of how many pounds were leaving the resource. This turned out to be more than we previously thought.

    This company is more of a long-term call option on uranium. It has no production today, and a uranium price of $48/lb would be necessary for it to move forward on its assets. On March 23, we reduced our target price from $3.50 to $2.25. This company's assets are vast, so investors who believe that the uranium price will spike will be interested in it.

    TMR: What's the best strategy for investors seeking to benefit from the expected growth of nuclear power?

    JR: There are two strategies I like. The first is targeting companies that are not getting full credit for assets that are expected to go into production in the next few years. The second is targeting companies, like Energy Fuels, whose portfolios are diversified enough such that they can wait out flat uranium prices.

    TMR: So you see uranium miners as a long-term investment?

    JR: Yes. The lead time of new uranium mines is long. So the ability to change the stories of these companies does not usually happen overnight, unless there is an acquisition, such as Energy Fuels buying Uranerz.

    As I said earlier, we expect higher uranium prices, but we haven't seen these companies move because most lack financial flexibility. Should the price of uranium reach the $60-70/lb range, these companies will show the cash flow level needed to justify higher valuation, in our opinion.

    TMR: Joe, thank you for your time and your insights.

    This interview was conducted by Kevin Michael Grace of The Mining Report and can be read in its entirety here.

    Joe Reagor is a research analyst with ROTH Capital Partners, providing equity research coverage of the natural resources sector. Prior to ROTH, he worked in equity research at Global Hunter Securities and at Very Independent Research, covering a wide array of resources companies including metals [steel and aluminum], mining [gold, silver and base metals] and forest products [containerboard, OCC, UFS and pulp]. Reagor earned a Bachelor of Arts in economics and mathematics from Monmouth University.

    Want to read more Mining Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Mining Report homepage.

    DISCLOSURE:

    1) Kevin Michael Grace conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
    2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Energy Fuels Inc. and Uranerz Energy Corp. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
    3) Joe Reagor: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
    4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
    5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports' terms of use and full legal disclaimer.

    6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their families are prohibited from making purchases and/or sales of those securities in the open market or otherwise during the up-to-four-week interval from the time of the interview until after it publishes.

    Streetwise - The Mining Report is Copyright © 2014 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (NYSE:I) only in whole (and always including this disclaimer), but (ii) never in part.

    Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported.

    Streetwise Reports LLC receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734.

    Participating companies provide the logos used in The Mining Report. These logos are trademarks and are the property of the individual companies.

    101 Second St., Suite 110
    Petaluma, CA 94952

    Tel.: (707) 981-8999
    Fax: (707) 981-8998
    Email: jluther@streetwisereports.com

    Apr 14 2:42 PM | Link | Comment!
  • With Expertise And A Little Luck, East West Petroleum Reels In Profits Despite Oil Price Plunge

    Many oil companies have been devastated by the oil price debacle. East West Petroleum, on the other hand, is making money, pumping more oil and strengthening its cash balance. CEO David Sidoo tells The Energy Report how shrewd joint ventures and a firm commitment to low costs have led to highly profitable wells in New Zealand and significant upside in Romania.

    The Energy Report: When was East West Petroleum Corp. (OTCPK:EWPMF) [EW:TSX.V] founded, and where do you operate?

    David Sidoo: East West was formed in 2010 on the back of the award of four exploration blocks in Romania's prolific Pannonian Basin. Following the award, we raised $30 million [$30M] to fund a work program and future business development. We then entered into joint ventures on these blocks with NIS (Naftna Industrija Srbije), the Serbian subsidiary of Gazprom. NIS is committed to funding Phase 1 exploration of €60 million (€60M) in exchange for 85%; we retain an interest of 15% carried through to commerciality.

    In 2012, East West entered New Zealand's Taranaki Basin with the award of three blocks held jointly with TAG Oil Ltd. Ten wells were drilled initially, and production and cash flow from New Zealand began in 2013.

    TER: What was your experience before you started East West?

    DS: I studied at the University of British Columbia [UBC] in Vancouver and played on its Thunderbirds football team. In 1982 we took home, for the first time, the Vanier Cup, the Canadian interuniversity championship. I then played professionally for six years in the Canadian Football League. After retiring from football in 1988, I entered the brokerage business and worked at Canaccord and Yorkton Securities for 11 years.

    TER: What did you learn from football that is applicable to business?

    DS: I learned that you can't build companies and achieve success on your own. You've got to have a good team around you. That's what we've assembled at East West. Most important, members of the team have to have strong technical knowledge. Next comes a good management squad that knows how to run a company, and has the expertise and connections to raise capital.

    TER: What was your experience in oil before East West?

    DS: More than a decade ago, I became involved in a company in the Pannonian Basin called Gasco Energy Inc. We secured acreage and raised over $150M. Gasco has some very good reserves and is doing well.

    We then formed a company called American Oil & Gas Inc. in 2013. We worked in the prolific Bakken fields in North and South Dakota, and sold the company to Hess Corp. for $630 million ($630M) in 2010.

    TER: What is your philosophy of building an oil company?

    DS: Our model has been to enter highly prospective areas early to build a material position, and then find companies with operational capabilities that complement our technical expertise. Our goal is to complete successful partnerships and maximize value to shareholders.

    As far as exploration goes, we're not interested in moose pasture. We want decent acreage in proven areas with infrastructure.

    TER: How does your management team give East West a competitive advantage?

    DS: We have the experience and the technical expertise. Aside from my own track record, Dr. Marc Bustin, a director who's our technical advisor, is a professor of petroleum and coal geology at UBC. He was awarded the Canadian Society of Petroleum Geologists' Stanley Slipper Gold Medal in 2013. He is world-renowned and has examined source rocks all over the world. He can quickly evaluate assets when we look for new opportunities. We're agile and nimble, and we can pull the trigger quickly.

    TER: What are the advantages of working in Romania and New Zealand?

    DS: Both have proven histories of oil production, which significantly derisks exploration. And both offer stable political environments with attractive fiscal terms. The netbacks in Romania and New Zealand are quite high, unlike many other places in the world. Working in these countries is quite similar to working in the United States or Canada.

    TER: What are the advantages of the joint venture [JV] model?

    DS: It allows explorers and producers like East West to diversify and hold a larger portfolio. JVs make our money go further. By partnering with professionals in the areas we operate, we benefit from their local expertise, while they gain access to our technical team's track record and history of reviewing many different projects around the world. You can never get enough trained eyes to evaluate projects.

    We have a substantial and successful history with this model. American Oil & Gas worked with Halliburton Co. This allowed us to monetize assets that were sold for $45M, which gave us the capital to develop our Bakken play.

    TER: What do your partners in Romania and New Zealand bring to the table?

    DS: In Romania, our partner NIS has extensive success operating in the Pannonian Basin. The company has been the leading oil producer for many decades in Serbia, which is just across the border from our southern two blocks.

    In New Zealand, TAG Oil is one of the leading operators and most active drillers in the Taranaki Basin. The company has a well-earned reputation in New Zealand for great community relations. We had long-term relationships with senior members of their team, which greatly facilitated our deal there.

    TER: How soon after you began exploration in New Zealand did you begin production?

    DS: We were awarded three concessions in New Zealand in December 2012, and began drilling our first well, E1, in August 2013, nine months later. We achieved our first production by year-end 2013. This was our first JV well, and it is still flowing naturally today, with little decline to date. I'll tell you something my wife always says I shouldn't say-you need to be a bit lucky. Some guys have a lot of luck and do well in business, and some don't.

    We're now producing about 330 barrels of oil equivalent per day [330 boe/d] at a cost of about $22 per boe, and that includes all royalties. With the Brent price at about $56 per barrel [$56/bbl], that makes our operations profitable, and allows us to fund the rest of this year's capital expenditure [capex)] from cash flow without using any of our $8.1M cash balance. Our rapid progress in New Zealand is a testament to TAG and to the country, which is very supportive of oil and gas development.

    TER: How much of your production is oil, and how much is gas?

    DS: Oil is 73%; 27% is gas. Right now we're only selling the oil; we're flaring the gas. But in about three months, a gas pipeline will be completed. That should reduce our cost per barrel to about $18.

    TER: What do you anticipate East West's year-end daily production to be?

    DS: We have one commitment well to drill later in 2015. Production should remain fairly steady, but we hope to raise it to perhaps 400 boe/d.

    TER: You announced the successful recompletion of your Cheal-E2 well in mid-March. How significant is that?

    DS: When E2 was drilled initially, in 2013, it did not produce. So its recompletion demonstrates the technical abilities of both TAG and East West. It provides the JV with an additional 100 boe/d for relatively low cost, and greatly improves our bottom line.

    TER: What's the status of your Romanian operation?

    DS: We are fully approved by the National Agency of Mineral Resources. Our JV has four blocks in Romania, and NIS has done seismic work to identify two drill locations on block number 7. NIS is permitting for one location as we speak, and we're hoping to drill by the end of the year.

    TER: You mentioned that East West is profitable, even with Brent at $56/bbl. How low would Brent have to fall before that profitability is threatened?

    DS: Breakeven for our operations is $35/bbl. That includes opex, salaries and all expenses. Today, many petroleum companies are shutting in oil wells or not completing them. They're waiting until oil rises to over $60/bbl, which is their breakeven cost. We're safe and sound now, selling at a Brent crude price even as we benefit from the weakness of the New Zealand and Canadian dollars. But when the price does rise above $60/bbl, we can start taking risks again.

    We've had people approach us for financing, but this would create dilution, so we're not interested. We're making money in New Zealand and we're carried in Romania, but the market isn't giving us any credit for the latter. We are discussing some other locations at the E site in New Zealand, but right now we're determined to focus on our bottom line and keep our general and administrative expenses low. When the market turns around-and this tends to happen fast in our space-we are poised to respond quickly.

    TER: As you said, your cash balance is $8.1M. How much of a cash cushion would you like to maintain?

    DS: I think a double-digit cushion never hurts. When you've got $0.10/share in cash in the bank, and you're building reserves, you start to look quite attractive to the market.

    TER: Despite your rapid advance to production and high margins, East West trades at only $0.15/share. What are you doing to persuade the market of the value of East West?

    DS: We are continuing to spread the word that we're a well-capitalized company, with profitable operations at current prices and meeting our financial obligations. It is our strong belief that when you build a good company, the stock price will follow.

    We were at $0.50/share with no production; now we're at $0.15/share with stable production. We'll be doing $3-4M this year at current oil prices, and we'll start selling our gas shortly. We have a strong shareholder base, and 15% of East West is owned by management. We are all shareholders here. I think there has never been a better time to buy this stock. We're derisked in New Zealand, and our cards are on the table.

    TER: Where do you see your company in three years' time?

    DS: We believe oil prices will likely stabilize in the next few years at $70-75/bbl. In three years, we would like to see production rise above 1,000 boe/d with no further dilution. We'd like to have $15-20M in the bank. We are already looking at increasing our acreage in New Zealand. Our operations in Romania should be well advanced by then. And then we'll look at acquiring a couple of other companies, bringing in partners and getting carried.

    Our shareholders have been really patient in Romania, which is great because we see real upside potential there. This is where we expect to get a big win in terms of developing toward that 1,000 boe/d.

    TER: David, thank you for your time and your insights.

    This interview was conducted by Kevin Michael Grace of The Energy Report and can be read in its entirety here.

    David Sidoo is president, CEO and a director of East West Petroleum Corp. Mr. Sidoo is a successful businessman based in Vancouver, where he oversees a successful private investment banking and financial management firm. Upon graduating from the University of British Columbia in 1982, where he held a four-year football scholarship with the UBC Thunderbirds, he was drafted to play professional football with the Canadian Football League. Mr. Sidoo retired from football in 1988 and was introduced to the brokerage business. From there he became a broker with Yorkton Securities, where he quickly became one of the company's top revenue generators. He went on to become partner and advisory board member at Yorkton Securities, consistently generating commissions that ranked in the top five nationally. In 1999, he left Yorkton to pursue private investment banking. He was founding shareholder of American Oil & Gas Inc. (AEZ), which was sold to Hess Corporation in 2010 for over US$630M in an all-stock transaction. In 2008, The Vancouver Sun voted Mr. Sidoo one of the top 100 South Asians making a difference in British Columbia. In 2014, Mr. Sidoo was appointed by the British Columbia government to the board of governors for the University of British Columbia.

    Want to read more Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Interviews page.

    DISCLOSURE:
    1) Kevin Michael Grace conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
    2) East West Petroleum Corp. paid Streetwise Reports to conduct, produce and distribute the interview.
    3) David Sidoo had final approval of the content and is wholly responsible for the validity of the statements. Opinions expressed are the opinions of David Sidoo and not of Streetwise Reports or its officers.
    4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
    5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports' terms of use and full legal disclaimer.
    6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their families are prohibited from making purchases and/or sales of those securities in the open market or otherwise during the up-to-four-week interval from the time of the interview until after it publishes.

    Tags: EWPMF
    Mar 26 7:50 PM | Link | Comment!
  • How Healthier Food Boosts Margins For Ag Companies And Investors: AltaCorp's John Chu

    More people are eating better, and demanding food with no gluten, more fiber, less fat and more protein. According to John Chu of AltaCorp Capital Inc., this trend equals tremendous growth potential for companies specializing in high-margin foodstuffs. In this interview with The Energy Report, Chu highlights one such specialty food stock, examines the effects of low oil and natural gas prices on the fertilizer space, and explains why he prefers the prospects of nitrogen-based fertilizers over potash.

    The Energy Report: How have the collapses in the prices of oil and natural gas affected the fertilizer sector?

    John Chu: Natural gas is an important feedstock for nitrogen-based fertilizers-up to 50% of the production cost. This means higher margins. Fuel and lubrication-related costs account for 10-12% of farmers' operating expenses. Lower fuel prices result in cost savings, which might be spent instead on fertilizers and other inputs. Lower gas prices should result in higher gasoline consumption, which in turn should result in greater ethanol demand and an increase in demand for the corn used to make ethanol.

    TER: There were recent reports that Russia was planning export duties as high as 35% on fertilizers. What effect would this have on the industry?

    JC: The rumors were unfounded. The Russian industry minister said that an export tax has no support and is not being discussed. In any event, we don't think an export tariff would have much of an impact. We would expect to see the Russian players continue to export most of their fertilizers to international markets-90% of potash, in particular. The Russian government has, in the past, floated the idea of an export tariff as a means to get domestic fertilizer suppliers to offer a meaningful discount to local farmers. And that is exactly what has happened; Russian fertilizer producers have agreed to a 33% discount for Russian farmers.

    TER: Have sanctions affected the Russian fertilizer space?

    JC: No. And we don't see them having an effect, especially on potash, because world supply is limited in terms of the different regions that can supply it.

    TER: When we spoke last summer, you mentioned the possibility of Russian producer Uralkali reforming its marketing alliance with Belaruskali, its Belarus equivalent. Did this happen?

    JC: No. It seems they're growing further apart, with Uralkali accusing Belaruskali of disrupting the market with higher volumes and price discounts.

    TER: We're hearing more about ever-closer political and economic bonds between Russia and China. Has this been reflected in the fertilizer market?

    JC: Uralkali held a conference call Mar. 5, and revealed that 2015 potash production will be reduced about 15% due to a flood at one of its mines. The company doesn't expect to lose market share in the U.S., Brazil or Europe, but we could see it lose market share in China and Southeast Asia. Uralkali will allocate volume based on netbacks and higher margin customers. We understand that Belaruskali and some other suppliers have been funneling a lot more volume into China relative to what Uralkali had in the past.

    TER: What is your 2015 projection for corn prices?

    JC: We expect that lower acreage will be planted in the U.S. and other key regions, and that yield will decline from the record achieved in the U.S. last year. We expect overall demand to remain pretty firm, based on feed demand, ethanol demand and increased demand from China. As a result, we expect higher prices: about $4-4.25 per bushel.

    TER: And your 2015 projection for fertilizers?

    JC: We haven't put out a hard forecast, but I can give you a sense of direction. We expect a $15 or so per tonne rise for potash. We think China will have to pay that much more, and that will greatly influence the cost to the other major customers. On the nitrogen side, we expect an equivalent $15 per tonne increase, driven by some supply disruptions and solid demand. We expect a more modest increase in phosphates, about $5-10 per tonne.

    TER: Why do you believe that, as you have said, fertilizers will "continue to act as a safe haven for resources funds"?

    JC: Portfolio managers in the materials, mining and energy sectors tell us that corn and fertilizers are more stable and involve lower risk, with higher prices expected.

    Fertilizer equities offer very solid dividend yields, anywhere from 2-4%. The capital expenditure [capex] programs for most of the senior fertilizer players in North America will fall starting in 2015, which suggests we'll see higher dividends and/or an increase in stock buybacks going forward.

    TER: How have shares of the nitrogen companies performed compared to the potash companies?

    JC: Agrium Inc. (NYSE:AGU) is up about 18% year-to-date. PotashCorp (NYSE:POT) is down about 6%. CF Industries Holdings Inc. (NYSE:CF) is up over 14%. The Mosaic Co. (NYSE:MOS) is essentially flat. Agrium and CF are the main nitrogen players. PotashCorp is obviously a potash player, while Mosaic is more of a phosphate player.

    TER: Agrium is your top pick of the majors. Could you expand on that?

    JC: We like its exposure to nitrogen, which is by far the most stable and predictable of all the fertilizer nutrients. Nitrogen has had a long upward trend of demand growth over a 40-year-plus period. The same can't be said for potash or phosphate. As I mentioned earlier, lower natural gas prices should help the cost side for many nitrogen producers, and we believe that nitrogen prices have bottomed. And nitrogen has a better outlook in terms of supply. Nitrogen has seen several global supply outages, with 4-5% of capacity coming offline due to gas disruptions or gas availability, mechanical problems, or political problems such as the Ukrainian upheaval. Many of those issues are expected to continue into 2015.

    Agrium also has a retail division, which offers good stability relative to the wholesale fertilizer business. It's been hitting record levels of sales the last couple of years. We're definitely impressed with that. We're also seeing increased disclosure and transparency from this company. It gave full-year guidance for 2015, for the first time ever. Agrium could be in line for a valuation rerating.

    TER: Agrium declared a $0.78 dividend last month. Can we expect higher dividends in the future?

    JC: The company's original dividend formula was 25-35% of free cash flow. It recently increased that to 40-50%. We expect that as its capex program declines free cash flow will increase, resulting in a higher dividend. From the perspective of a base-case scenario of projected free cash flow from 2016 through 2021, we could see a $4-5 dividend per share. Based on the company's upside-case scenario, we could see a $5.90-7.40 per share dividend.

    TER: Agrium announced an aggregate $1 billion [$1B] debt issue of 10-and 20-year debentures on Feb. 25. Is this troubling?

    JC: No, it's just standard debt management.

    TER: Among the companies you cover, how do you rate Agrium's peers?

    JC: We cover PotashCorp. We're concerned about the potash side because of the possibility of oversupply. We had inventory restocking in 2014 and, as I've already noted, Belaruskali is flooding the market and offering price discounts. This is not good for the potash price outlook.

    TER: PotashCorp just bought 9.5% of the Brazilian company Fertilizantes Heringer S.A. [FHER3.SA:Sao Paolo] for $55.7 million [$55.7M]. Is this significant?

    JC: It's certainly very interesting. It's a good move for the company because Brazil is one of the top three fertilizer consumption markets in the world, and we believe there's substantially more upside as to how much fertilizer the country can import and consume.

    The Moroccan state fertilizer company OCP (Office Chérifien des Phosphates) bought a 10% stake in Heringer in January. This led to a long-term supply agreement whereby OCP will provide Heringer with phosphate-based products. I think PotashCorp is hoping they can do something similar with Heringer: a long-term supply agreement with a large fertilizer producer and distributor in one of the world's fastest-growing fertilizer markets.

    TER: Your January industry update highlighted the emerging importance of the "higher-margin food ingredient sector." Could you explain what that is?

    JC: It relates to the desire of health-conscience consumers for non-GMO, gluten-free, low-fat, high protein and high fiber diets. Food companies are responding to this and also moving toward higher efficiency, sustainability and having smaller carbon footprints.

    To give an example, AGT Food and Ingredients Inc. (OTCPK:AGXXF) [AGT:TSX] had traditionally processed crops by sorting, dehulling and cleaning. The problem with that approach was that it resulted in lower margins, in the high single-digits. The company is now taking a different approach. Instead of merely cleaning and sorting a crop, it is processing it even further, into pulses-food ingredients that food companies can then use. This approach results in much higher margins, double and perhaps even greater.

    TER: Pulses are lentils, peas, beans and chickpeas? Is that correct?

    JC: Foods like that, yes. These pulses are now being incorporated into healthier breads, chips, soups, peanut butter and even beverages. This is a huge opportunity for the food industry, the potential of which is still in the early stages.

    TER: How do consumers know that food products contain higher value food materials?

    JC: Through advertising. The healthier ingredients will be reflected in labeling, which will note lower saturated fat contents, higher fiber and protein contents, that the food is non-GMO, etc. Higher-value foods are getting a big push from big industry players. General Mills has introduced it into Cheerios. Whole Foods and Walmart are moving in this direction.

    TER: AGT announced an $80M bought-deal financing in October. What does the company intend to do with that money?

    JC: Some of it will pay down debt. Some of it will go toward fine-tuning its plant in Minot, North Dakota. The rest will be spent to convert existing excess capacity at its legacy facilities in Canada, the U.S. and Turkey to produce pulse ingredients, and add an additional pasta line in Turkey.

    AGT stock was up 67% in 2014 on the basis of its food ingredient initiative and its joint venture with Ingredion Inc. (NYSE:INGR), a company with a $5.7B market cap.

    TER: AGT stock rose to almost $30/share in February but has since fallen to about $27/share. Have we seen the end of its run?

    JC: I don't think so. The company will report results in the next couple of weeks, and update the investment community on its progress in converting excess plant capacity to pulse ingredients. This conversion will essentially raise utilization rates and improve margins. We'll probably also hear final plans regarding the addition of a new pasta line. These data points down the road will provide much more clarity regarding AGT's expansion, and should help fuel continued momentum for the stock.

    TER: Your industry update also highlighted the emerging importance of what you call "non-traditional agriculture."

    JC: There's one particular company in this sphere we like: Input Capital Corp. (OTC:INPCF) [INP:TSX.V], which streams canola.

    TER: Input recently announced its intention to consider streaming soybeans as well. What do you think of that?

    JC: It's definitely a smaller market opportunity, but interesting nonetheless. There are about 50,000 canola farmers in Canada, but only about 6,500 soybean farmers. Most canola farmers are on the prairies, whereas 85% of soybean farmers are in Ontario. When Input presented farmers with the opportunity to stream canola, what the company heard from some farmers was that there was less of an interest in canola, and more in soybeans.

    TER: Considering that soybeans are considered health food, and given the increasing popularity of Asian food, could the soybean market earn a significantly larger share of Canadian agriculture?

    JC: I would expect both soybeans and corn to generate potentially larger market shares. And both deliver substantially better margins than wheat.

    TER: How diversified could Input become?

    JC: The company is somewhat limited by the nature of the market. Input's concept is built around futures contracts, which enable pricing visibility going forward. Soybeans are in the oil-seed complex with canola, and the prices are fairly well correlated with each other. Crops without futures contracts would be much harder to stream. For example, I don't think Input would look at wheat. Actually, I don't think the company is in a position to look beyond soybeans now, because there's so much untapped opportunity on the canola side.

    TER: How do you rate Input in terms of the number of contracts it has signed, and in terms of its balance sheet?

    JC: The company announced it had deployed $16.9M as of the quarter ending December. That was a very nice surprise, considering it is a seasonally weak period. The company signed 26 contracts, of which 24 were new. That demonstrates a growing confidence in streaming within the farming community. The January-to-May period is the time when Input will be busiest.

    Input has got about $50M cash. No complaints there.

    TER: Let's talk about companies in the ancillary ag space.

    JC: I'll mention three we like. The first is Ag Growth International Inc. (OTCPK:AGGZF) [AFN:TSX], which is in the handling and storage business. AG was one of our top picks in 2014, and was up about 26% that year. The company announced a $90M public offering on Dec. 1, to partially fund its acquisition of Westeel from Vicwest Inc. (OTC:VICUF) [VIC:TSX]. Westeel is involved in green storage and has a dominant market share in western Canada. This complements Ag Growth's core business, as grain handling and storage work hand-in-hand, and should help drive earnings in 2015.

    Ag Growth has also demonstrated good growth in international markets-specifically in Ukraine, despite that country's difficulties. The company is looking at expanding its Brazilian operations. It is beginning with a small greenfield expansion, with the hope that it can become more substantial. We're pretty excited to consider what this company can do in Brazil, given its upside in storage and grain handling. We like this name for 2015 and beyond.

    TER: And the other two companies are?

    JC: The other two are in transportation. The first is Cervus Equipment Corp. (OTC:CSQPF) [CVL:TSX], a well-diversified company and a potential sleeper for 2015. It is the largest John Deere dealer in Canada, and has some exposure in Australia and New Zealand. It has also has an industrial transportation component, which is about a third of its business.

    Cervus made several acquisitions in the second half of 2014, and these should help drive 2015 earnings growth. This might actually surprise some people, because the 2015 ag equipment environment will generally be troublesome. Fortunately, the company has good exposure to the used vehicles, parts and service sectors. If farmers aren't buying new equipment, they are likely to buy used equipment instead, which would help offset new equipment sales weakness. In addition, Cervus will further offset losses with its high-margin (higher than equipment sales) equipment servicing side.

    Rocky Mountain Dealerships Inc. (OTCQX:RCKXF) [RME:TSX] has a very strong brand name. Rocky is more Canada-based than Cervus-not as geographically diversified. But like Cervus, they also have exposure to used equipment and the higher-margin sales and service business.

    We believe there's an opportunity for this company to become involved in the ongoing consolidation of the equipment industry and to expand into the U.S. with acquisitions there. We hope to see that happen. Once again, this is a challenging environment, but the Canada-based equipment players should do better because Canadian farming is expected to be down only 7% year-to-year in 2015, as compared to American farming, which is expected to be down 22%.

    TER: To sum up, what are the best choices for investors in agricultural products?

    JC: We like the nitrogen players rather than potash, and Agrium is our best bet for that sector. The market for healthier foods is expected to show a substantial increase, and therefore companies with a growing stake in that market will demonstrate higher margins, which in turn will lead to better visibility, more stability and, in time, higher valuations.

    TER: John, thank you for your time and your insights.

    This interview was conducted by Kevin Michael Grace of The Energy Report and can be read in its entirety here.

    John Chu, CFA, is managing director of agri-industry institutional equity research at AltaCorp Capital Inc. He was previously senior vice president in agriculture and industrials research at Mackie Research Capital, and also worked for Scotia Capital and HSBC Securities. He holds a bachelor's degree with honors in economics from Queens University, and a master's degree in business administration from the University of Western Ontario.

    Want to read more Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Interviews page.

    DISCLOSURE:
    1) Kevin Michael Grace conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
    2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Input Capital Corp. Streetwise Reports does not accept stock in exchange for its services.
    3) John Chu: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. AltaCorp Capital is a market maker for the following companies mentioned in this interview: Agrium Inc. AltaCorp Capital was involved in an equity financing for Input Capital Corp. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
    4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
    5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports' terms of use and full legal disclaimer.
    6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their families are prohibited from making purchases and/or sales of those securities in the open market or otherwise during the up-to-four-week interval from the time of the interview until after it publishes.

    Tags: energy
    Mar 19 5:53 PM | Link | Comment!
Full index of posts »
Latest Followers

StockTalks

  • " $INPCF is off to a great start using canola as the underlying crop"-Spencer Churchill. Read More:http://ow.ly/QccGs
    5 days ago
  • "Higher biodiesel production and RIN prices support an improving outlook for $REGI"-Craig Irwin. Read More: http://ow.ly/PBH1v
    Jul 14, 2015
  • "The real upside in $POEFF's story in the near term is exploration drilling in Indonesia"-Bill Newman. Read More: http://ow.ly/PBGLf
    Jul 14, 2015
More »

Latest Comments


Posts by Themes
Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.