NexGen Energy (NYSEMKT:NXE) released results of the long awaited PEA for its world-class Arrow uranium project. The results definitely haven't disappointed. The Arrow mine is expected to produce 18.5 million lb uranium per year over an initial 14.4-year mine life. Over the first five years, the average annual production should reach 27.6 million lb uranium. With such production profile, Arrow overshadows any other uranium mine, McArthur River and Cigar Lake included.
Another important factor is that the projected costs are very reasonable. The pre-production CAPEX is estimated at C$1.19 billion, or $952 million, using the exchange rate used in the PEA (C$1 = $0.8). For comparison, Cameco's (NYSE:CCJ) Cigar Lake mine CAPEX climbed up to $2.6 billion (however, it is important to note that it was inflated by several unexpected events). The main advantages of the Arrow deposit are that it is shallow (the upper limit of the deposit is situated only 100 meters below surface), it is basement-hosted (as a result, the production costs will be lower compared to the typical Athabasca basin sandstone hosted uranium deposits) and the uranium grades are very high (6.88% for indicated resources and 1.3% for inferred resources). The average operating costs are estimated at $4.42/lb U3O8 over the first five years and at $6.7/lb U3O8 over the life of mine. The Arrow mine should be at the bottom of the uranium industry cost curve.
Source: NexGen Energy
Also the sustaining CAPEX is quite low, only $468 million. It equals approximately to $1.76/lb U3O8 over the life of mine. As a result, it is possible to assume that the AISC should be less than $10. It means that the mine should be highly profitable even at the current depressed uranium prices of approximately $20/lb.
The after-tax NPV (8%) is $800 million and the after-tax IRR is 27% at a uranium price of $25/lb. The project has a high leverage to growing uranium prices. A $5 growth of uranium prices adds approximately $400 million to the NPV. At uranium price of $50, the NPV is $2.8 billion and the IRR is 56.7%. Due to the relatively low CAPEX, also the after-tax cash payback is very quick. It is 2.4 years at a uranium price of $25/lb and only 1.1 years at a uranium price of $50.
NexGen Energy and the uranium industry
As shown by the table below, the Arrow mine should become a real behemoth. The world's biggest uranium mine, McArthur River, produced 15.3 million lb uranium in 2016. The average annual life of mine production of the Arrow mine is estimated at 18.5 million lb, which is 21% higher compared to McArthur River. Moreover, over the first five years, the average annual production should reach 27.6 million lb uranium. It is 80% more than the 2016 McArthur River uranium production.
Source: Own processing using data of NexGen Energy and Investingnews.com
The importance of the proposed mining operation is very well illustrated also by the following chart. The Arrow mine should be large enough not only to become the biggest uranium mine in the world but also to make NexGen Energy the second biggest uranium producer in the world.
Source: Own processing, using data of NexGen Energy and the World Nuclear Association
The timing seems to be great for NexGen Energy. Probably all of the analysts agree that the uranium market is about to enter an era of significant deficits. The charts below show the expectations of some institutions and research companies. Not only is the uranium production expected to start to decline rapidly, as the long period of weak uranium prices lead to a significant reduction of investments into exploration and development of new deposits, but also the demand for uranium is expected to grow rapidly, mainly due to countries like China or India. China has only 36 operating nuclear reactors, but 21 are under construction and another 215 are planned. The Indian energy policy follows a similar path. In India, 22 nuclear reactors are operating, five are under construction and 64 more are being projected.
Source: NexGen Energy
Various sources talk about a uranium market deficit in the range of 50-100 million lb by 2025. By 2030, it could grow to 100-150 million lb per year. If the projections are true, 5-10 Arrow mines will be needed to fill the gap, which is obviously unrealistic. In this light, the base-case uranium price of $50/lb used in NexGen's PEA doesn't seem to be so high.
This is not the end (the exploration potential)
Although the results presented by the PEA are very good, this is not the end. It's just the beginning. The PEA is based on a resource estimate from March 2017 that includes only drill results up to December 20, 2016. The resource estimate outlined indicated resources of 179.5 million lb U3O8 (at a uranium grade of 6.88%) and inferred resources of 164.9 million lb U3O8 (at a uranium grade of 1.3%). The summer and winter 2017 drill program consisting of 66,000 meters of drilling was not included. Given the recent drill results, the resources will be expanded notably. An updated resource estimate should be expected in late 2017 or early 2018. And sometimes during 2018, also the results of the pre-feasibility study should be announced.
Multiple drill holes drilled this year discovered additional intervals of uranium mineralization and more are to come, as the Arrow deposit is still open in several directions and at depth. The company is enthusiastic especially about the potential of A2 and A3 zones (maps below).
Source: NexGen Energy
But Arrow is not the only uranium deposit on NexGen's Rook 1 property. In August 2016, NexGen discovered another zone of mineralization located only 4.7 kilometers to the northeast of Arrow. It was named Harpoon. Some of the most interesting drill interceptions at Harpoon include 17.5 meters grading 3.89% U3O8 or 13.5 meters grading 3.94% uranium.
And only last week, NexGen announced the discovery of Arrow South. Arrow south is located 400 meters to the south of Arrow. According to the press release:
The South Arrow Discovery has been tested with only two holes and both intersected narrow intervals of off-scale radioactivity within a large and robust envelope of highly prospective hydrothermal alteration. South Arrow remains open in all directions.
Source: NexGen Energy
As shown in the pictures above, the Arrow South anomaly is similar to the Arrow anomaly. Although the exploration of Arrow South has only begun, there is some potential that NexGen discovered another big uranium deposit. The true potential of Arrow South should be confirmed in the coming months as it became the focus of the summer drilling program.
The potential financing options and the price targets
Although the true extent of the Arrow deposit hasn't been defined yet, the PEA shows that NexGen owns an outstanding project. The production volumes should be high, the production costs should be low and the initial CAPEX is reasonable. Given that the economics of the project are really impressive, it is located in a safe and mining-friendly jurisdiction and the outlook of the uranium market is very positive, there is a high probability that NexGen will be able to build the Arrow mine on its own.
Right now, there are slightly more than 338 million shares outstanding. At the current share price of $2.48, the market value of NexGen is almost $840 million. Given the size of the company and the economics of the project, NexGen should have no problem to finance at least 50% of CAPEX, or approximately $500 million via debt. The worst case scenario is that the rest would be covered by an equity financing. At the current share price, NexGen would have to issue approximately 200 million new shares, which means a 60% dilution. However, NexGen must complete the pre-feasibility and the feasibility study first. It is reasonable to expect that the feasibility study will be completed in late 2018 at best. More probably, it will be completed sometime in H1 2019. And it must also obtain all the necessary permits. Although it shouldn't be too complicated, as there are several uranium mines in the region, it will take some time. It means that NexGen has at least 18-24 months to push its share price higher by aggressively drilling its properties and adding more and more resources and reserves. Moreover, it is highly probable that by 2019, also the uranium prices will be higher than today, which should help to push NexGen's share price higher. And a higher share price means a lower dilution.
Except debt and equity financing, there is another possibility. Although streaming agreements are usually used by gold and silver miners, there is no reason why it couldn't be used by a uranium miner. There are entities that surely would like to secure stable long-term deliveries of uranium at favorable fixed prices. A stream of 10-15% of the Arrow mine production (according to the PEA, it equals to 1.85-2.8 million lb of uranium per year or 26.6-40 million lb uranium over the 14.4-year mine life) should be easily worth at least $500 million, depending on the actual uranium price.
How high will the value of NexGen's shares climb if it takes the Arrow mine into production is only hard to estimate, as it is yet unknown how the actual financing package will look like, how many shares there will be outstanding and how high the uranium price will be. And also some of the metrics of the project may change during the PFS and FS phases. However, I tried to outline several scenarios taking into account the results of the PEA (the average life of mine numbers), different share counts, different uranium prices and price to free cash-flow ratio of 8, which is slightly lower than Cameco's current price to free cash-flow ratio of 8.86.
Let's start with the "worst case scenario" that NexGen will have to issue 200 million shares (as mentioned above). If the convertible debentures are converted, there will be another 50 million shares outstanding. It means that in this scenario after the financing is done, there should be almost 600 million shares outstanding. At an average annual production of 18.5 million lb uranium and at AISC of $10, the free cash-flow generated by the mine should be approximately $185 million, using the current very low uranium price of $20/lb. Cameco's price to free cash-flow ratio stands at 8.86 right now. Conservatively attributing a lower ratio of 8 to NexGen, we can come to a market value of $1.48 billion. At 600 million shares outstanding, the share price should be $2.47.
Source: Own calculations
As the table above shows, if the company avoids excessive share dilution, there is a notable upside potential even at the current low uranium price. However, it is highly probable that when the Arrow mine gets into production, the uranium prices will be notably higher. In this case, the $10 mark is definitely not out of question.
NexGen Energy as an acquisition target
Based on the exceptional exploration results, NexGen Energy has been a natural acquisition target for some time now. After the PEA, it became a red-hot acquisition target. NexGen Energy is a uranium industry major player in the making. Its world biggest uranium mine can be built at a reasonable price and NexGen will probably be able to build it alone. Any major uranium miner that doesn't want to lose its market share must be considering a bid right now.
And there is also the Chinese factor. China is known for its insatiable appetite for commodities. Right now, there are 36 nuclear reactors operating in China. Another 21 reactors are under construction and 215 are planned for the next decade. China is going to need huge volumes of uranium in the future. And China is known for its strategic long-term thinking. This is why the Arrow deposit and the other deposits owned by NexGen Energy should be very attractive to the Chinese investors. Moreover, the Chinese have already invested in NexGen Energy. Last year, a Hong-Kong based company CEF Holdings Limited purchased convertible debentures worth $60 million. And this year, in July, the same company purchased shares worth $50 million and convertible debentures worth another $60 million.
As of July 31, NexGen held cash of C$200 million ($160 million), which means that it is well financed to push the arrow project forward as well as to keep on exploring its properties aggressively. The market value of the company is almost $900 million, which means that acquiring NexGen Energy definitely won't be cheap. And it will probably get only more expensive as the time goes by. It is possible to assume that a successful bidder should offer at least a 50-100% premium, which means that the acquisition would cost $1.35-1.8 billion at least. This obviously limits the group of potential bidders.
Out of the major uranium producers, only BHP Billiton (NYSE:BHP), Rio Tinto (NYSE:RIO), Cameco and Areva (OTCPK:ARVCF) have a market capitalization over $1.8 billion. Paladin Energy (OTCPK:PALAF) is definitely out of question, as it is too small. Out of the above-mentioned companies, Areva and Cameco probably won't be able to acquire NexGen, as both of the companies have their own issues. The low uranium prices had a negative impact on their financial stability. Areva had to be saved by the French government, only last year. Cameco's market value declined by 50% to $4 billion over the last five years. Moreover, the company has huge issues with the Canadian Revenue Agency, due to the supposed tax evasions worth almost $2 billion. Both BHP Billiton and Rio Tinto are strong enough to acquire NexGen Energy. BHP Billiton, as well as Rio Tinto, would be able to become the biggest uranium producer in the world, thanks to the acquisition. It is an attractive vision, as the fundamentals indicate that the uranium market is on the brink of a strong multi-year bull market.
Kazatomprom, Uranium One, CNNC & CGN, and Navoi are not exchange traded, and it is hard to estimate their value and true size. Out of these four companies, CNNC and CGN are the most probable bidders. CNNC (China National Nuclear Corp.) and CGN (China General Nuclear Power Corp.) are Chinese state controlled companies operating in the nuclear power sector. CNNC is a state-owned company focused on developing nuclear technologies. It is also responsible for Chinese national strategic nuclear forces and nuclear energy development. CGN develops nuclear technologies, it operates its own nuclear power plants and it also produces nuclear fuel. According to CGN's webpage, CGN is the largest nuclear power operator in China and the largest nuclear power constructor worldwide. Both of the companies are strong enough to make a serious bid for NexGen Energy.
NexGen Energy's Arrow deposit is about to become the biggest uranium mine in the world. And NexGen Energy has a real potential to become one of the biggest uranium producers in the world. Unless it gets acquired. NexGen being acquired is a very real possibility now after the PEA confirmed the exceptionality of the Arrow project. But the potential acquirers have to start moving quickly, as NexGen is well financed to drill its uranium-stacked properties aggressively and push the Arrow project forward. Moreover, the uranium prices are expected to start moving up finally. All of these factors indicate that the longer the bidders wait, the more they will have to pay. If NexGen Energy resists and makes it into production, the investors will be rewarded handsomely. And if the company gets acquired over the next 6-12 months, it is reasonable to expect that it will be for $3.75-5 per share at least.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in NXE over 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.
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