brighter than they first appear!
Monday, June 2, 2008
By Virginia Heffernan
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Prices of uranium equities have fallen by about 50% on average since peaking a year ago. The unexpected rout has left many investors wondering if the four-year bull market for uranium has come to an end, or if they should be bargain-hunting oversold stocks that still have growth potential.
Analysts with Royal Bank of Canada?s capital markets division, in a report released at the end of April, say this depends on the company. Some share prices are undervalued compared with the spot market. Other share prices are implying a uranium price of considerably more than the current spot price of US$63 a pound of U3O8 (the most common form of uranium). These prices are much higher than their peers, despite heavy declines across the sector.
Spot market prices for uranium have been in free fall since late June 2007, when they hit a high of US$136/lb. of U3O8, up from US$7/lb. in 2000. But the tight market and speculative buying that characterized the first half of 2007 has given way to downward pressure. The RBC report attributes that trend to intensive selling by traders and a ?take it or leave it? approach to spot market purchases by utilities, which prefer to deal in longer-term contracts.
As a result, even though the long-term future for uranium demand still looks rosy as governments around the world become more favourably inclined toward the metal as an energy source, the spot market is not reflecting that outlook. Spot prices are down by more than 60% from last June, and equities ? some more than others ? have followed suit.
Among the RBC report?s undervalued equity group is the world?s largest uranium producer, Saskatoon-based Cameco Corp. Its stock was hammered last year after the company announced that production from its Cigar Lake mine would be delayed until at least 2011 as a result of widespread flooding in the developing mine.
The RBC report estimates that Cameco?s recent share price (about $40 on the Toronto Stock Exchange) implies a spot uranium price of about US$44.50. The report gives a 12-month target of $49 a share for the producer.
?We believe that Cameco will probably continue to be the best name among uranium producers, especially since the water-related risks at Cigar Lake have been reduced recently and it has a top-tier asset base that is in production,? RBC analysts Adam Schatzker and Fraser Phillips wrote in the report.
For longer-term exposure to the uranium market, the report recommends Johannesburg-based First Uranium Corp., Toronto-based Aurora Energy Resources Inc. and Denver-based Ur-Energy Inc., three TSX-listed companies that are developing or exploring uranium projects in different parts of the world.
Among developers, the RBC report favours First Uranium as a ?cheap gold company with free uranium exposure? from the company?s Ezulwini gold/uranium mine in South Africa, as well as Ur-Energy because it has lots of cash and is a potential takeover target.
Among the explorers, the report says, Aurora stands out for its strong leverage to the uranium price. Aurora plans to continue with a pre-feasibility study on the Michelin project in Labrador, even though the Labrador Inuit government just passed a three-year moratorium on uranium mining on its land while it makes decisions regarding resources development. Aurora plans to begin production at Michelin in about five years.
On the other hand, the report considers producers Uranium One Inc. of Vancouver and Paladin Energy Ltd. of Western Australia to be overvalued. The performance risk at Uranium One?s Dominion Reef mine in South Africa ? for which this year?s production forecasts were slashed by 32% because of power disruptions and other factors ? combined with the political risk associated with the company?s uranium assets in Kazakhstan, is too high to warrant Uranium One?s $2.2-billion market capitalization.
Paladin, once the darling among uranium equities and still implying a U3O8 value of US$90/lb., says it is on track to produce 2.6 million lbs. of U3O8 in 2008 and 4.7 million lbs. in 2009 from its Langer Heinrich mine in Namibia and its Kayelekera project in Malawi. But the RBC report says Paladin?s management may be expecting more than they can deliver, especially for the Phase III expansion at Langer Heinrich.
?We think that some of the equities are trading at fairly high levels and that this premium may come down,? says the report. ?However, both Uranium One and Paladin are the growth companies in the uranium industry and investors have tended to flock to them when they put money into this industry.?
Many opportunities in this sector remain for clients who believe the world economy will remain strong, says John Wong, who manages Geiger Counter Fund, a London-based fund that invests in uranium equities.
?We are still at a very early stage in the bull market,? he told Resource Investor, an online source of mining news and analysis. ?Last year was an anomaly, when the market overheated and some companies became unrealistically valued.?
The supply/demand balance remains favourable for companies with long-term resources, Wong says. He believes such companies will undergo consolidation, while companies that lack genuine prospects will be decimated.
Geiger Counter Fund?s holdings are spread among Australian, British, Canadian and South African equities, including strong positions in Uranium One and Perth-based Berkeley Resources Ltd., another RBC analysts? favourite that is in the process of securing six advanced uranium exploration projects in Spain.
The prospects for uranium companies are not as closely tied to the spot price of uranium as the market would suggest. There are two prices analysts use to gauge the direction of the uranium market: the spot price and the long-term price. Although the spot price has plummeted over the past year because of strong selling and a lack of necessity on the part of utilities to buy on the spot market ? Georgia-based Ux Consulting Co. LLC, which tracks the market, reports that 82% of the spot purchasing in the first quarter of 2008 was discretionary ? the long-term price has remained unchanged at US$95/lb. for the past year.
Some market insiders believe that the long-term price is a better gauge of the ongoing supply/demand imbalance, but the RBC report argues that it is also an imperfect measure; that?s because the price reflects only a small portion of U3O8 contract sales: ?We believe the real clearing price for the market lies somewhere in between the currently quoted spot and long-term prices. In our view, if all materials were to be sold on the spot market today, an equilibrium price would probably be in the US$85-US$100/lb. range, given the demand/supply fundamentals and the ever-increasing cost of new mine production.?
As a result of unexpected supply disruptions, mainly attributed to a power crisis in southern Africa, Ux Consulting has reduced its 2008 forecast for global supply to 123 million lbs. from 129 million lbs. Demand is expected to remain steady, at about 185 million lbs. a year, with the deficit made up by secondary supply.
Wong sees supply as the market?s main short-term driver. He says further disappointments on the supply side are likely because there are not enough geologists and mining engineers trained in uranium to meet demand. In addition, there are shortages of vital consumables, such as sulphuric acid, and the power crisis in South Africa is far from over.
The message to investors? Ura-nium equities ? depending on their current valuation with respect to the spot price, long-term resources and existing sales contracts ? remain a sound investment, and may even be a bargain considering long-term supply/demand fundamentals. IE
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