An interview where Old West portfolio manager Brian Laks discusses his views on the uranium market and specific companies to take advantage of the potential bull market coming.
Recently, the spot price has surged 30% after key global mines like Cigar Lake or Kazatomprom’s have shut down due to Covid-19 precautions. What’s next?
What’s the best way to play the uranium bull thesis? Brian lays out his views regarding specific jurisdictions, stage of development, and individual equities.
Today I have the pleasure to interview Brian Laks, Portfolio Manager and Partner of Old West Investment Management, who also manages a special opportunity fund that is now focused on uranium. In his prior role, he focused on the energy sector. He is a CFA charterholder.
I have been following Brian Laks (BL) for a while now due to my interest in the uranium sector since 2018. I have listened to several of his interviews on different shows (see at the bottom of this interview). Given the recent events happening in the uranium world, I wanted to ask him a few questions to learn more about his views regarding the supply/demand situation and how he thinks things will develop from here, but particularly I wanted to focus on how investors should better take advantage of the opportunity, dealing with how best to allocate capital within the sector and specific companies. Of course, we start by talking about his investment approach and how he views general markets now. We could have extended this conversation longer, but that perhaps it’s for some future occasion if readers are interested in learning more. Hope you enjoy it!
Q. For those who don’t know you, please, why don’t you tell us about your investment approach? What are the things that excite you the most when looking for investment opportunities?
BL. I tend to be drawn to deep value situations where there are large gaps between price and value. These could be industries that have undergone some sort of structural change or are complex and difficult for the average investor to understand. Once we identify these situations, we also like to see meaningful catalysts on the horizon that will serve to unlock that value for our investors over reasonable time frames.
Q. At Old West you had been cautious on the broader markets for a while. I assume you must have benefited nicely from market hedges. What are your views of the broad market now? Have you sold your hedges entirely or you think it’s still time to be cautious?
BL. We had a fairly cautious stance going into the recent downturn. It’s easy to forget that the market was hitting all-time highs in mid-February even as news of the virus spreading outside of China became more prevalent. We took advantage of the extremely low volatility to increase our hedges substantially. Within a few weeks many of them had multiplied in value; in some cases, dramatically. Some of our hedges linked to volatility returned over 3,000%.
We were able to take those profits and redeploy them into our investments that had sold off in spite of the fundamentals remaining strong. In many cases, the outlooks had actually improved. We still have a small hedge position that we may look to increase if the recent market rally continues. We believe the economic implications of the crisis are only beginning to be felt and the stimulus measures have merely provided short-term relief.
Q. And what about specific opportunities after the recent sell-off? Do you see value in the oil & gas space?
BL. Our biggest weighting outside of uranium is in the gold industry. We have been bullish on gold for several years and are finally seeing the thesis play out. Central banks around the world have thrown unprecedented amounts of money at trying to combat the economic effects of this crisis, and we believe those efforts will lead to much higher gold prices in the future.
We specifically like the miners here because of the operating leverage that serves as a magnifier to any move in the underlying commodity price. We have been buying long-term call options on the miners as a right-tail hedge because we believe there is a possibility the gold price overshoots even our optimistic forecasts.
As for oil & gas, we have very little exposure at the moment. We understand the bull case and believe there is value to be realized in the future, but the demand destruction that has occurred in the short term and the unclear path forward lead us to prefer other areas at this time.
Q. Let’s now focus on the uranium market. First up, of course, we have to cover the macro picture and the recent announcements regarding mine closures and thus production cuts. Consequently, uranium spot price has surged. Can you provide us with some context to better understand the implications of these recent events?
Source: TD Securities.
BL. The uranium market was already in deficit heading into this year as a result of meaningful supply cuts over the past several years in the face of steadily increasing demand. Recent mine closures have only served to heighten that supply uncertainty. A majority of global production has either been reduced or taken offline completely, and in some cases those suppliers have entered the market as buyers to supplement their lost production.
Contract discussions between producers and utilities had already been taking place at prices well above current market levels. If there were any urgency on the part of utilities to begin contracting, it has only been amplified by recent developments.
Q. We have been waiting for utilities to start contracting pounds with uranium producers at decent prices (i.e. north of $40), but be it because of political uncertainties (section 232, NFWG…), high enough inventories, complacency or whatever else, they haven’t done so, at least at enough scale. Is the current situation the catalyst for utilities to start getting to the view that supply risks are significant and they should start securing pounds now before it’s too late?
BL. We believe it is. Utilities have been able to delay contracting the last few years by drawing down inventory and relying on traders to supplement their short- to medium-term needs. A prolonged period of low prices has given the appearance of abundant supply and led to a complacency that now seems to be shifting.
With inventories reaching historically low levels and an increase in spot pricing challenging the profitability of carry trades, both of those outlets have diminished. We think the increased uncertainty of future supply along with rising price indicators will give the fuel buyers justification to sign contracts at price levels necessary to balance the market.
Q. As a consequence of the recent spot price surge, we are seeing now spot price above the reported term price for the first time in many years, which has been pointed out by some as a meaningful sign. But I wonder whether that is a reliable indicator, given how the “term price” is measured here. What do you think that means?
BL. There are several issues with how the term price is reported that lead some industry observers to question its reliability. The contracts from which those prices are derived often have confidentiality provisions which prevent the disclosure of their terms, so the sample set from which the price reporters get their data may not be indicative of the true level of activity in a given period. Compounding this issue is the practice of “best offer” reporting, in which a low-priced offer may be reported as the price even if transactions took place at much higher levels. The spot price has its own issues as well. The spot market is mostly made up of traders churning pounds back and forth with only a small portion being physically delivered, and thus may not accurately reflect actual supply/demand in the industry.
Regardless of their shortcomings, many people focus on these prices for lack of a better alternative. With spot above term as you mentioned, an interesting dynamic occurs. Traders who had been active in the market, buying cheap spot material and carrying it for several years to sell into a higher term price, have seen that spread collapse and may be reluctant to re-enter the market, reducing a source of supply for utilities. Additionally, those utilities who had been hesitant to sign contracts at the high prices demanded by producers may now be more willing to do so as the price environment changes.
Source: TD Securities.
Q. It looks like the market has started to focus on supply risks, while demand issues are now at the second stage. We recently read that the coronavirus outbreak won’t impact nuclear power plant construction in China. That’s good. However, we have also just seen negative effects on the nuclear output forecast in France. What are your thoughts on the impact of the current situation on nuclear energy generation and uranium demand both in the short term and medium to longer term?
BL. Unlike other commodities that have seen significant demand destruction in this environment, uranium demand has been relatively unaffected. Nuclear plants are designed to be extremely reliable and capable of operating in adverse conditions. They provide baseload electricity and maintain a relatively constant level of output regardless of fluctuations in demand. Other forms of generation, such as natural gas or coal, have the ability to rapidly cycle on and off and are used instead to offset temporary changes in demand.
France is a unique case because they get most of their electricity from nuclear power. They had some maintenance work that was affected which is reducing output this year, but they expect it to rebound next year. For the most part, nuclear power globally has been extremely resilient.
Given the length of the fuel cycle and utility procurement process, buying decisions in this industry are made years in advance. Today’s demand is for material that will be used several years from now, and it is the forecasted supply/demand at that point in time that determines those decisions.
Longer term, demand is driven by national energy policies and the role that nuclear power plays in that mix. There is a growing recognition that nuclear power is an excellent source of clean, carbon-free electricity and many countries are pursuing large reactor build programs. With over 50 reactors under construction today and hundreds more planned or proposed, the future demand for uranium is very strong.
Q. Despite the uranium spot price being at four-year highs after rising over 25% YTD, most uranium equities are down big time in the last few years, and some are even red YTD. This may speak to how far down the uranium price went compared to average production cost in the industry, in the sense that the recent uptick is far from enough to satisfy uranium companies’ needs. It may also speak to how skeptical the overall market is. What’s your take here regarding the behavior of uranium equities?
BL. If you had only watched the uranium equities over the last few years, you would be surprised to see that uranium has actually been in a steady uptrend over that time. The price is up 70% since bottoming in late 2016, including a 30% move in the last few weeks. Even with those moves, the price is still far below the marginal cost of the industry which has led to that divergence in performance.
Source: TD Securities.
The equities have had a substantial move off the March lows, but many of them are still only at levels seen as recently as a few months ago. Our view is that the rise in price is only beginning and the increasing supply deficit will continue to push it upward until it provides the proper incentive for the development of new supply. This in turn will lead the equities higher as investors gain confidence that those incentive levels will be reached.
Q. I know your opportunity fund is widely diversified among different names, but also jurisdictions and stages of development. Last time I listened to you publicly (December 2019), you said you had lowered the risk of your uranium portfolio by moving away from stocks in the explorer side shifting to companies closer to producing. Have you made changes to the general approach to the portfolio and its allocation lately?
BL. We continue to believe that companies with a solid roadmap to production and cash flow offer the best leverage to the coming cycle. We have recently increased our weightings in companies that have shorter time-to-production, which we believe will be valued more highly now relative to those with the lowest costs. Many of the low-cost projects have longer development timelines and in a shortage scenario the marginal cost may be set by projects that can deliver pounds the quickest.
As we look forward, given the accelerated rebalancing timeline that appears to have developed with the mine shutdowns, we may consider revisiting some of the longer tail exploration plays. We have also been looking at other areas of the fuel cycle beyond mining where we believe there are interesting opportunities. Two names to mention there would be Centrus Energy (LEU) and BWX Technologies (BWXT).
Q. I can infer from that that US current producers (if we can call them that, as they almost stopped producing at all) that might ramp-up production rapidly or care & maintenance mines and some highly-advanced development stories in Africa may fit into that. What’s your thinking about relative jurisdiction attractiveness now?
BL. Shorter-cycle projects have definitely increased in attractiveness. We took advantage of the selloff in March to increase our positions in Africa because we felt the selloff there was overdone given the projects had become much more attractive in this environment. Companies that have idled capacity are also very interesting because of the short lead times and relatively low capital requirements. Boss Resources in Australia would be one example with a project like that. Vimy Resources also has an Australian project that, while not a restart, can be developed fairly quickly.
The US still appears to be a government sourcing story. As you mentioned earlier, we increased our weighting to the country last summer after the dramatic selloff that accompanied the Section 232 announcement. Our view was that the creation of the Nuclear Fuel Working Group was a positive for the industry, even if the timeline had been extended.
In February, the President released his budget which included $150 million for the creation of a strategic uranium reserve, confirming our belief that the government intended to support the industry. In March, the Secretary of Energy appeared in front of Congress to discuss that initiative and spoke very strongly about the importance of maintaining a domestic supply chain.
We think Energy Fuels (NYSEMKT:UUUU) will become one of the prime contractors to the government in this arrangement. Because of the large capacity of their mill, additional mining assets will be needed to fill it to optimal capacity. Once a contract is signed, they can turn around and begin forming JVs or signing toll milling agreements with other sources of supply. There are a few junior companies that have nearby projects that could fill that gap, such as Encore Energy (OTCQB:ENCUF), Laramide Resources (OTCPK:LMRXF) and Western Uranium (OTCQX:WSTRF).
Q. Moving on to specific companies, there has been some debate regarding which of the two listed majors might be a better investment, Cameco or Kazatomprom. What’s your take?
BL. We think they are great companies and own them both.
Up until two years ago, only Cameco (NYSE:CCJ) was publicly traded. It was considered the bellwether of the industry and a standard choice for many investors. They have large, high-quality assets and decades of experience as a reliable supplier. They are also conservatively run, and structure their contracts accordingly, so investors looking for pure leverage to the uranium price may be disappointed to see a dampened sensitivity to varying levels of the commodity price. The benefit, of course, is that their downside is well-protected.
Kazatomprom has dominant market share and some of the lowest-cost assets in the world. Their preference for market-linked pricing will give them more leverage to a rising price environment, but may expose them to more risk if the price does stay lower for longer. The Kazakh sovereign wealth fund also owns the vast majority of the shares, so investors should consider the implications of that as well.
Q. The Athabasca basin is the highest-grade region by far and thus where costs are lowest. But as you mentioned above, that also comes with shortcomings. Many development plays are very far into the future. Some have technical hurdles to overcome. Others require extremely high CapEx budgets to advance. What’s your thinking here?
BL. We try to always remember that uranium is a commodity and in commodities, over the long run, low cost wins. Those with the lowest cost projects are able to better withstand the cyclicality of the industry, when low prices can drive many higher-cost players out of business. In the shorter term, however, those issues you mention do play a role in the relative attractiveness of the projects. There are three major development projects in the basin that are often discussed.
NexGen’s (NYSEMKT:NXE) Arrow is a behemoth, designed to produce roughly 30 million pounds a year, which would be a significant chunk of global supply. Not only is it incredibly large, but the extremely high grades mean it would be one of the lowest cost mines in the world. Aside from the high initial cost, one of the criticisms we hear is that it actually might be too large! 30 million pounds of material will require some finesse to place into the market without causing too much of an impact on prices. Our view is that this project is a natural acquisition target for Cameco whose Cigar Lake mine is scheduled to be depleted by the end of the decade. Cameco already has the relationships with utilities to be able to place those pounds strategically into existing contracts or manage them in inventory for future contracting.
Denison’s (NYSEMKT:DNN) Wheeler River project, which includes the Phoenix and Gryphon deposits, is not quite as large but has similar low costs. They benefit from being in the eastern portion of the basin where there is already well-developed infrastructure, saving them on capital costs, yet there are a few additional technical hurdles they have to manage. The plan for Phoenix is to use in-situ recovery, a mining method popular in Kazakhstan and the US, wherein the uranium is dissolved underground and pumped out in liquid form. Much of the world’s uranium is produced this way, but it would be the first application in Canada, where the sandstone in which the deposit is located is water-saturated and must be artificially frozen.
Fission (OTCQX:FCUUF) has the other big project in the basin (Triple R). CGN, the Chinese uranium mining company, bought a large stake in the company at a significant premium to the current valuation. Its project is just south of NexGen’s in the western portion of the basin and carries a similarly high initial cost because of the infrastructure that must be developed. The deposit is also situated under a lake which presents some additional challenges.
Investors with a bit more risk tolerance could look further out the spectrum at some of the exploration companies. Two that look promising are IsoEnergy (OTCQX:ISENF) and Purepoint (OTC:PUMGF) which both have demonstrated high grade drill results.
Q. You have been public in the past about your overweight in Energy Fuels. Is it still the case, and if so, what is it that you like the most? Wonder if you could comment on their recent capital raise and the management track record regarding dilution. Also, can you walk us through your process when valuing how much Energy Fuels (as an example for others) should be worth?
BL. We are still significant shareholders of Energy Fuels (UUUU) and continue to believe they will be the primary beneficiary of domestic industry support, which now looks to be forthcoming. The recent capital raise was criticized by some who felt it was done at an inopportune time with the share price near multi-year lows. Like most juniors with little or no cash flow, they have to raise money to maintain their operations. Given the scale of their asset footprint, ongoing costs are higher than those of their past-producing peers such as Ur-Energy (NYSEMKT:URG), Peninsula Energy (OTC:PENMF), and Uranium Energy Corp (NYSEMKT:UEC). As much as we dislike to see dilution, we think the benefits of being well-capitalized as the cycle turns will more than offset any downside of having done so.
We use a variety of methods to value the company. We view it as much as a processing company as we do a mining company because of their ownership of the White Mesa mill. We can look at the replacement cost of that mill, for example, to get an idea of what that portion of the business might be worth. Any new mill would likely require years to permit and hundreds of millions of dollars to build, which is well in excess of the current value of the company.
We also look at production capacity and model out financial performance under various scenarios. For example, looking out several years we estimate the company can get to 4 million pounds of uranium production per year. If we go back to the last time they were producing a substantial amount, their costs were around $35/lb. We model a $60 price which we think is a reasonable level the market will reach, giving them an annual gross profit of $100 million.
They have made good progress reducing operating costs and overhead the last few years to under $30 million. Even if we inflate that for conservatism, we think the company can ultimately earn $50 million per year, or 40 cents per share. At 10x earnings it would trade at $4 per share. In an improving uranium market where they have the dominant position in the US, it’s not hard to imagine it reaching 20x earnings in which case you could see it trade for $8 per share in the next few years.
Q. Focusing on Africa, I get the arguments to have exposure there, in terms of the cheaper and quicker permitting process as well as strategic importance given geopolitical considerations. We have several companies with different business models and stages of development. All seem to have appealing features. Global Atomic has cash flow from zinc operations to finance Dasa project and good mine economics, GoviEx has strong financial backing and support from the Niger government, Paladin has a proven asset in care and maintenance mode ready to start producing when market conditions warrant… To name just three names. Of course, we can build an equal-weighted basket of names in Africa, but what is it that you focus while thinking on the African region?
BL. We think these will be some of the first projects to come into production this cycle. The ease of permitting and level of advancement relative to other regions make these ideal candidates for development.
In the case of Namibia, Paladin (OTCPK:PALAF) has an asset with a proven history of production that can be brought online with relatively little time and money. Bannerman (OTCQB:BNNLF) also has a very large project that is well defined. While higher cost, we think it provides excellent leverage to a sustained rise in uranium prices and given its scale would be a natural target for a state-owned entity, if not developed on a standalone basis.
Paladin’s Langer Heinrich Mine.
The Nigerien assets are quite attractive to us as well. Many investors tend to shy away from that part of the world, but Niger has a long history of uranium mining. It has provided a steady supply of uranium to the French, who have one of the largest nuclear fleets in the world. Orano, the French nuclear giant, is scheduled to see their COMINAK mine shut down next year and may have an eye to developing future supply in the region.
We like Global Atomic (OTCQX:GLATF) for their size and grade, and the cash-flowing business you mentioned helps them minimize the dilution that other junior miners often require. They recently issued an updated economic analysis that considers an accelerated development of a portion of their deposit that could potentially see them bring on relatively low-cost production in the next few years. GoviEx (OTCQB:GVXXF) has another large project in the country and the involvement of the Nigerien government gives us great confidence in its prospects.
Q. Some experienced fund managers who are also bullish uranium have said this is the best risk-reward opportunity they have ever seen. Regardless of their relative claim, can you tell us what your return expectation is for a basket of companies in the sector, like your own fund? In this regard, do you come up with target prices of the different companies, and how reliable do you consider them to be in such a volatile sector?
BL. We agree it is one of the best opportunities we’ve ever come across, which is one of the reasons we launched a fund to focus on it. We tend to be conservative with our return expectations, but it’s easy to see why many investors are excited. In the last bull market, the uranium price increased more than tenfold with many equities returning a multiple of that.
Because we focus on companies with viable paths to production, we can value the forecasted cash flows of their individual projects. Given how severe and prolonged the industry downturn was, many of these companies currently trade at a fraction of what of those projects are worth in a normalized environment. We would expect a well-constructed basket of uranium equities to return at least 3 to 5 times its current value over the next few years.
Q. I can’t close the interview without this last question. What is your advice for new investors that are coming now to the uranium space and want to get exposure?
BL. My advice would be to learn as much as you can. This is a complicated industry and trying to piece it all together can be difficult. Investors often ask us if we regret being early to the idea, but the tradeoff for spending that time is that once the turn comes we have already done the work. We know the industry well and have an informed view on the companies and their projects.
Given the steep learning curve, new investors may want to consider the various ETFs and physical holding vehicles that are available. ETFs such as URNM in the US, HURA in Canada, and GCL in London provide investors with a basket of uranium mining companies. There are also physical funds which give investors a way to access the appreciation in the underlying commodity such as Uranium Participation Corp (OTCPK:URPTF) in Canada and Yellow Cake (OTCPK:YLLXF) in London.
Source: Seeking Alpha