Summary
- Global uranium supply is decreasing, and the long-term demand is increasing.
- Cameco is testing the depth of the spot market with significant purchases to fulfill long-term delivery commitments.
- Cameco is one of the few companies that remain consistently cash flow positive in the industry.
- Energy Fuels’ spare capacity makes them an interesting investment in a short-term recovery scenario.
Investment Thesis
We are finally seeing significant supply reduction from the uranium producers. Cameco Corporation (CCJ) with positive free cash flows and Energy Fuels (UUUU) that has substantial spare capacity is an interesting combination from a risk-reward perspective.
Supply Side
The spot price of uranium is presently trading well below the average cost of production which naturally leads to very limited investments by the uranium producers. The longer the market stays at these levels, the more limited long-term supply will be.
In the short term, we have also seen a large number of producers reducing production, and most noticeable are the two main global producers Cameco Corporation and Kazatomprom. Kazatomprom will, over the next three years, decrease production by 20%. Cameco on the other side has worked to reduce production over a few years. During 2016, they produced 27M lbs and in 2017 24M lbs.
For 2018, they have contract commitments of 37-38M lbs, but they expect to produce only about 9M lbs. The remaining 28-29M lbs will be purchased in the market or taken from the inventory. This will be a real test to the depth of the market which can prove beneficial for the entire industry.
Demand Side
There are presently a number of countries in the world where nuclear energy is being phased out or planned to be phased out. Germany, Belgium, or France are a few examples. These countries are at the same time highly committed to reducing carbon emissions. How that equation will add up in the short to medium term I have at least not seen any compelling evidence for.
France, for example, has pushed forward their deadline when they expect to stop relying on nuclear energy. I think Germany will continue to serve as a cautionary example here. They have started to phase out nuclear energy to be replaced with renewable sources, but they have also had to rely on coal plants to supplement the shortfall in energy production.
In more emerging countries, the demand for nuclear energy is significantly higher. According to Cameco, there are presently 55 reactors under constructions with China, India, and Russia leading the expansion. In countries like China where pollution is causing reduced quality of life, a significant number of deaths and diseases, nuclear energy is viewed very differently compared to the west.
We have also seen more and more reactors come back online in Japan. Seven reactors have now been restarted, and a few more are expected to start this year.
Cameco
At current prices, virtually all uranium producers are losing money on the bottom line when including depreciation. What really sets Cameco apart is a reasonably good portfolio of medium-term contracts which allows them to stay cash flow positive by curtailing investments, arbitraging the spot market and focus on cost savings.
Over the last three years, Cameco has had positive free cash flows. For 2017, free cash flow was about $Cdn500M, and, in Q1 2018, FCF was $Cdn270M. Q1 2018 was affected by the bringing forward of some longer term contracts. So, if we are conservative and focus on 2017 FCF, the company is trading at a Price to Free Cash Flow of 11.6 which is very satisfactory when keeping in mind that the uranium market is fairly depressed.
Cameco Legal Disputes
There are two legal disputes which could have significant effect on the balance sheet of Cameco. TEPCO cancelled their contracts with Cameco arguing “force majeure” after the Fukushima disaster. Cameco is in turn seeking damages of around US$700M due to the differences of contract values and market prices at the time. The dispute is expected to be heard in Q1 2019, but apart from legal cost, there is effectively only upside to Cameco here.
Cameco has for some time now been going through a dispute with Canada Revenue Agency (NASDAQ:CRA) over revenue recognition in Canada. The initial trial concluded in September 2017, and the decision is expected within 6 to 18 months from that date. The ruling in turn is likely to be appealed by the losing party which could prolong the final decision for a few more years. If the final decision goes against Cameco, we are talking about a significant figure in the area of Cdn$2B. The company has cash and a credit line to cover the majority of this amount, but this decision has the potential to cut the stock price in half.
Energy Fuels
Energy Fuels is the largest uranium producer in the US but still small in comparison to Cameco. They have like most uranium producers negative earnings and are also cash flow negative. Energy Fuels is good complement to a Cameco investment for a couple of reasons.
- Energy Fuels have significant spare capacity with only a minority of their assets in production, so there is significant growth potential under better market conditions
- The company is more exposed to the spot price which could potentially overturn long-term contract levels in a supply glut
- They would be a large benefactor if the US seeks more nuclear energy independence which has been petitioned to the US Department of Commerce
Having said that, the market needs to turn around reasonably quickly for Energy Fuels. They will otherwise likely have to recapitalise within a year or two, so the investment is more speculative.
Conclusions
Cameco is not without risk, specifically due to the CRN tax dispute. The company has large upside potential when the market finally turns around, they have the ability to remain cash flow positive if the recovery takes longer and still offers some downside protection.
Energy Fuels on the other side have very large upside potential but limited downside protection. The market needs to turn around within a year or two; otherwise, the company is likely to have to refinance. I view the Energy Fuels investment more as 1-2 year option on the uranium market and should be positioned accordingly.
Source: Seeking Alpha
