- “We still think we are a long way from the exit” says Brian Laks from Old West Investment Management, a firm which launched a fund focused on the uranium opportunity.
- We catch up almost a year later after our first interview and a strong rally in uranium equities, as institutional investors have been entering the sector.
- Brian shares his views on what’s next, portfolio allocation at this stage, ideas on specific companies and other issues such as valuation or the exit strategy.
It is my pleasure to introduce readers to my follow-up interview with Brian Laks, Old West Investment Management’s Portfolio Manager, devoted to the uranium investment opportunity – where I have also been personally invested for a while. Although a bit outdated now due to how quick things are moving performance-wise, I recommend reading Old West Q4 letter, which goes into more detail.
Brian and I talked almost a year ago, when the COVID-19 shock on uranium supply had already pushed the spot price up significantly. However, after recovering from the market crash, uranium equities did very little. It wasn’t until November last year when stock prices woke up and volume exploded, with some impressive moves. This was only a few months after I wrote a piece on The Art Of A Successful Contrarian Investor, reflecting upon the developments in this sector and some of the challenges and frustrations of an investor betting on its bull thesis to play out.
The recent rally in uranium equities is why I wanted to catch up with Brian after our first interview. I wanted to get his views on what’s changed in the uranium sector in the last year and how they are positioning their portfolios after the initial strong move in the equities. We talk about specific names and he shares some thoughts on valuation, as well as his expectations on how this investment may play out going forward. Finally, he mentions a few other areas where Old West has been deploying capital recently or that they are keeping a close eye on.
Q. It’s been almost a year since our first interview. Sentiment towards uranium equities has shifted very positively, particularly since December, while on the surface the uranium market and the spot price had been stagnant until very recently (and is still below $30). What is behind the recent rally?
BL. There are several things we think have combined to drive the equities higher. Institutional interest appears to be growing steadily. Average volumes across the space have picked up dramatically in the last few months. For a small, relatively illiquid sector it’s not surprising to see this kind of price strength as it attempts to absorb these flows. In addition, the sector ETFs—long derided for their passive selling during the downturn—have now become buyers. The two largest have over $700 million in assets and continue to grow.
General market conditions are also supportive. A year of lockdown and stimulus checks seems to have brought about a resurgence of day trading activity reminiscent of the late 90s dotcom bubble. Denison Mines (NYSEMKT:DNN) in particular was the target of an apparently random speculative frenzy which saw the share price quickly double on daily volume that was ten times the previous record. Some of these investors appeared to know nothing more about the company than its ticker symbol. A decent fraction, however, may have been introduced to the uranium thesis as evidenced by the increased volume of commentary on social media.
As for the spot market, while we pay attention to the activity that occurs there, we are not overly concerned with the lack of movement because we don’t believe it necessarily reflects the long-term fundamentals of the industry. Participants there have a variety of motivations, not all of which relate to their overall supply/demand forecast years into the future. We do think the era of utilities dipping into the spot market to fulfill their needs is coming to a close as there is a growing recognition that meaningful long-term contracts need to be signed. Even the industry consulting groups which they rely on have begun to change their tune and are now warning about future supply availability.
Q. In what ways have your views on the uranium market changed since our previous interview in April? Has your view regarding where uranium prices will go changed over the last year?
BL. A lot has changed in only a year and we are more confident now in the idea than we have ever been. When we last spoke, Cameco (NYSE:CCJ) and Kazatomprom had just announced major production cuts and entered the spot market as buyers. More recently, a number of producers and investment vehicles have raised funds to acquire material from the spot market, which we think could force the issue as utilities find more competition when looking to purchase their unfilled requirements.
Industry observers had long been warning about the need for prices to rise to give the proper signals for the development of new supply. With the long lead times of many of the major projects, these signals needed to be received well in advance of the actual time the material would be needed. Because this has taken longer than expected, we think there is now a greater chance the price overshoots the equilibrium, which many believe to be in excess of $60 per pound. Even Cameco, typically a voice of cautious optimism in the sector, echoed as much in a recent conference call.
Q. Has that affected your portfolio positioning and allocation to the sector? Thoughts on allocation in this part of the cycle?
BL. Our portfolio has become much more concentrated over the last year. Many companies in the sector have seen their share price increase 5-10 times off the lows as a rising tide lifted all boats. We still think there will be additional growth in valuations across the sector but have become more selective and concentrated in the handful of names that we feel have the strongest long-term positioning.
We have continued to increase our weighting to low-cost producers and those with nearer-term production, such as past producers that are currently idled or development projects that can be brought on relatively quickly. Combined with large-scale, low-cost development projects in Canada, we think the portfolio has a nice balance.
Q. I’d like to ask you about the role African mines can play in this bull market. Some say that, beyond quicker lead times due to regulation among other factors, Africa is a very attractive place geopolitically given the huge growth expected in demand from emerging countries, particularly China and India, and the fact that these countries may find the African region as an easier place to do business with – perhaps taking over some of the current companies. Do you find this theory compelling? What are your favorite African plays?
BL. We think Africa will certainly play a role this cycle and agree that large state-owned enterprises will be a driving force. In fact, we’ve already seen this to some extent with China’s activities in Namibia. The ore grades in Africa are typically much lower than you find in other parts of the world, leading to higher costs, but the short cycle times suggest it may be some of the first new material on the market. Our two largest positions there are Global Atomic (OTCQX:GLATF) and Paladin Energy (OTCPK:PALAF).
Global’s DASA project is relatively high grade for the region, can be developed in stages (minimizing upfront capex), and will be a welcome source of new material as the COMINAK mine shuts down. They are unique in that they also have a joint venture in a zinc processing plant which provides cash flow, allowing them to minimize the dilution necessary to enter production.
Paladin’s Langer Heinrich mine is a past producer that is currently pending restart. They recently completed a transformational equity raise that significantly improved their capital structure, and we think they will be a major producer in the future. We also have a small position in Lotus Resources, which is planning to restart the Kayelekera mine in Malawi.
Q. You’re one of the largest shareholders of Energy Fuels (UUUU), a company we talked about in our previous interview. Since then, there hasn’t been any material impact from the U.S. Uranium Reserve, but they have made some progress on the Rare Earths front. That has had some news flow and attracted some interest but also raised additional skepticism from some investors in the uranium space, as if they were pivoting away from uranium to “the next big thing.” What’s your take on the company?
BL. Like many investors, we initially discovered the company through our work on uranium, as it was one of the leading US companies in both production and potential capacity. At the time, there was a lot of talk about the government potentially looking to provide support to the domestic uranium mining industry and we viewed the company as a primary beneficiary if that were to occur. An immediate attraction for us, and one that differentiated it from the other US miners, was their ownership of the White Mesa Mill, the only operational uranium mill in the country.
The flexibility to process multiple feedstock and produce many different products is a valuable feature of that asset, and we think skeptics are mistaken to dismiss it as a lack of focus. We see it as a key piece of US infrastructure at a time when the US government is intent on rebuilding domestic supplies of critical minerals. It is understandable that investors who are purely focused on uranium might underestimate the rare earth potential. We are far more concerned with seeing the facility resume operation than we are with whatever specific product may be demanded by the market at a given time.
With China controlling almost all of global rare earth capacity, supply chain fragility is even more acute than it is with uranium where the largest producer is only 40% of the market. The process the company has devised is extremely capital efficient, with processing infrastructure already in place and source material already mined. The monazite they plan to use has a better composition of valuable heavy rare earth elements than other proposed ore sources which also have to contend with those massive capital requirements. We believe there will be plenty of uranium produced from White Mesa in the future; but if they are able to generate additional cash flow in the meantime from other products, we view that as a positive.
Q. What excites you the most in the current uranium equity space?
BL. The most exciting thing for us is that awareness of the opportunity is finally starting to grow among an increasing number of investors, especially institutions. There was a period not too long ago where only a handful of voices were shouting into the void about a structural supply deficit forming, and very little coverage outside of a few niche media outlets.
We are finally seeing some confirmation of the thesis in the form of a rerating of equity valuations, which we think is only beginning. The drumbeat of positive nuclear sentiment continues to grow louder. There has been a continued call for the next generation of reactors especially by highly visible activists such as Bill Gates, whose TerraPower startup was recently awarded funding by the DOE under their Advanced Reactor Demonstration Program. We continue to like Centrus Energy (LEU) as our preferred way to gain exposure to that theme, which has an agreement with TerraPower to commercialize HALEU fuel.
Q. What is your preferred way to assess the valuation and upside potential of uranium equities? What are the challenges you find when comparing the values among the different stages of development or jurisdiction?
BL. As traditional value investors, our framework is very similar to how we would approach any other investment. There are certain factors that are specific to mining companies, but at the heart of it we look at the assets and try to determine what cash flows they can generate under a variety of scenarios. For uranium development projects, the technical reports many of the companies file often include economic models which we can reconstruct to test individual assumptions and examine what the cash flows would look like in different situations.
As you get further from production, more uncertainty is added to the forecast. Earlier-stage projects may not have that level of analysis available and you may need to look at comparable projects to construct a financial model. Looking at precedent transactions can also be helpful if you believe the asset might be acquired prior to entering production.
For exploration stage companies, we may not even know the extent of the deposit. One of our best performing investments in the sector has been IsoEnergy (OTCQX:ISENF), which still hasn’t released a maiden resource estimate. In that case, we were so impressed by the drill results that we initiated a position because we believed there was evidence of sufficient high-grade material to eventually justify the development of a mine.
Q. While a few months ago the issue of the exit strategy seemed too far away to be worried about, with the strong and rapid rise in stock prices one might do well having a plan now before things start to get crazy. What are your thoughts on exit strategy from the uranium investments?
BL. We still think we are a long way from the exit. The equities have started to signal an impending rise in the commodity price, but price alone is not sufficient to dictate the end of the cycle. A structural supply/demand imbalance now exists, and until that is remedied, we would expect to see continued strength in the sector. This process could take years, as necessary price signals invite enough new supply development to cover future demand, but it’s also possible that equity valuations price in that scenario before it occurs.
One of the decisions we made with our fund was to launch small and steadily raise capital over time to better capture the bottoming process that occurred over the last few years. Just as we built positions gradually in these companies, we will likely scale out of them as valuations improve.
For asymmetric opportunities, the magnitude of the upside is much more important to us than the precision of the outcome. If a stock is at 1 and we think it’s worth 8, we probably won’t be upset if it ends up at 7 or 9 instead. If we’re even remotely close it will be a huge success. Likewise, relative valuation differences typically play less of a role early on, when capital is flowing broadly into the sector, than they do when the overall industry valuation is more robust. By the time people are splitting hairs over appropriate multiples, we will probably be long gone. We may maintain a few positions in higher quality names, but will likely be more focused on the next opportunity.
Q. I’d like to end this uranium set of questions with a short Q&A on specific uranium companies:
- In Athabasca, what’s your favorite company: Fission (OTCQX:FCUUF), NexGen (NYSEMKT:NXE) or Denison?
- In the US, URG or UUUU?
- Cameco or Kazatomprom?
BL. NexGen is our favorite company in the basin, and no surprise it is one of our largest positions. The size and grade of the project is unmatched and we think it may actually be the best development project in any commodity. We own Denison Mines as well. Even though it is smaller in size and has a few additional technical challenges, the quality of the deposit is world class.
Energy Fuels is our preferred way to gain exposure to the US market. As discussed earlier, we think the mill is a big differentiator and the additional revenue opportunities are extremely attractive.
Kazatomprom is our favorite producer given their dominant market position, low cost of production and cheap valuation, though there are some qualitative aspects that may cause the valuation discount to linger. We also own Cameco which we think will be the go-to name for institutions to participate in the uranium space.
Q. Outside of uranium, where is your focus now in the markets? Where are you finding the most interesting opportunities?
BL. Believe it or not, most of the work we do now is outside the sector. That’s not to say we find the idea any less compelling; we have over $100 million invested in uranium and believe a multi-year bull market is just beginning. But the majority of that research has already been done. What we are looking for now are the future opportunities where we might redeploy the expected profits as the thesis plays out over the next few years.
We still prefer areas that have great prospects if you’re willing to look out 3-5 years but where current sentiment might be poor. A perfect example of this is in commodities. It is remarkable the extent to which they have underperformed other areas of the market in light of the unprecedented monetary stimulus that should ultimately benefit them through higher inflation.
Metals in general are appealing to us here. Many of the large diversified miners trade at low valuations with strong dividend yields that we view as not only sustainable but likely to grow as inflationary forces put upward pressure on prices. Gold miners are especially attractive. The price of gold has been falling for the last 6 months, dragging many of the miners along with it, but the companies still produce substantial cash flow at current price levels. Our preference is for companies with low-cost assets in safe jurisdictions, such as Kirkland Lake (KL), which is one we have been adding to on weakness.
Outside of commodities, we are finding some interesting opportunities in aerospace and defense. Conventional wisdom used to be that Democratic administrations were negative for military spending, but we believe the last few months have blown up that idea. Geopolitical tensions continue to escalate and provide a strong tailwind for the industry. Lockheed Martin (LMT) is interesting as a market leader with strong free cash generation, low valuation, and a solid yield. They are at the forefront of some of the more advanced areas where we see strongest growth such as energy weapons, hypersonic vehicles, and outer space.
Recent exuberance in financial markets has highlighted the role of certain players that dominate financial market infrastructure such as Virtu Financial (VIRT), which is one of our largest positions. We originally liked them as a countercyclical play on market volatility, an attribute that was proven during the market selloff in late 2018. More recently, they have been a major beneficiary of increased retail trading volume as one of the largest market makers handling order flow.
For more long-term thinkers, we like to spend a little time on things that are much farther out. One of our favorite sources of new ideas is to follow the developments of national laboratories and international science collaborations. While these scientific breakthroughs may not be immediately actionable, they can provide a nice road map of where certain things are headed and the materials and technologies that will be needed to support them.
Anyone who has spent time researching nuclear power can tell you one of the main attractions of uranium as a power source is its specific energy, or energy per unit mass. Splitting the nuclei in a kilogram of uranium can provide millions of times more energy than burning a kilogram of coal. Nuclear fusion and antimatter are the only two options that are known to be superior, with roughly 10 and 1,000 times the specific energy of uranium, respectively.
These theoretical energy sources are still decades away from power generation but research and development in attempting to harness them only continues to grow. We believe there may be some interesting pick-and-shovel plays that feed into the massive infrastructure needed to support their development—areas such as cryogenics, electromagnets, superconductors, and other specialty metals and alloys. We think the periodic table will become an increasingly important source of investment ideas in the future.
Lastly, we are still quite concerned with general valuation levels in many areas of the market. We’ve started to see some cracks form as interest rates have risen making long-duration growth assets relatively less attractive. We continue to maintain certain hedges that have highly convex payoffs if these valuations prove unsustainable.
Source: Seeking Alpha