Tuesday, April 3, 2007

Uranium Mining Sector Notes -- Large Cap Value in Uranium Mining

Uranium has been one of the highest appreciating sectors over the past three years and shows no signs of slowing down. There are a limited number of public Uranium miners, evidenced by the fact that the Canadian investment management firm Sprott Asset Management -- which is one of the best research firms covering the Uranium sector -- only lists 34 firms in their Uranium universe. Further, there is especially a limited number of "quality" names -- quality meaning a reasonable chance of bringing sizable uranium to market profitably in a reasonable time frame (7-8 years).

The Large Pure Play Uranium Miners:

There are only two large, pure play Uranium miners that currently produce Uranium as a large percentage of their total production: Cameco -- currently the world's largest producer, located in Canada -- and Energy Resources of Australia (ERA), which is 68% owned by Rio Tinto. There are 3 other mid-tier producers of Uranium, which produce Uranium from smaller, geographically dispersed mines: Uranium One, Denison, and Paladin. BHP is the world's third largest producer of Uranium, due to its ownership of the Olympic Dam mine, but Uranium so far only comprises a small percentage of BHP's total sales and operating income (estimated 2.5% and 3.0%, respectively in 2006)

Note that currently the world's supply of Uranium is heavily dependent on only a few mines. Nearly 100% of all new mined uranium is derived from only 10 mines worldwide, and approximately 40% of all newly mined uranium is derived from only three mines: 1. The McArthur River Mine -- owned by Cameco in Canada, at 17% of world production; 2. Olympic Dam -- now owned by BHP (Australia) at 9% of world production; 3. Ranger 3 -- owned by Energy Resources of Australia (ERA) at 12% of world production.

Cameco and ERA can be compared in valuation as follows:

Ticker; Company Name; Market Cap; P/E (Trailing), P/E (forecasted); P/S (Trailing); Reserves (Measured + Inferred); Gross Value Reserves (at $100 lb U3O8); Market Cap/Gross Value Reserves
CCJ; Cameco; $15.5Bn; 43.8x; 17.4x; 9.25x; 526.4 Mlbs*; $52.6Bn; 29.5%

ERA (ASX); Energy Resources of Australia; $Au5.5Bn; 128x; n/a; 16.9x; 524.2 Mlbs;** $52.4Bn; 9.4%

*CCJ reserves also include 2.5M ou of Gold, note an amount comparable with a junior gold miner, and also amounts of zinc, copper and nickel comparable with small junior miners of these metals
**Reserves of ERA are only two mines, Ranger and Jabiluka, and approximately 70% of total ERA reserves in the "Jabiluka" mine, which has not been approved for production as of mid-07.

CCJ and ERA's mines are currently operating in politically stable countries (although Australia's political attitude towards new uranium mines is interesting, the subject for another post -- in summary there is a lot of resistance to new uranium mines in Australia) and have proven geology and infrastructure for getting the uranium to market. Mines in Kazahkstan and African and South American countries should be reviewed carefully before investing due to political risk. The mid-tier uranium miners Uranium One, Denison, and Paladin have significant operations in Kazahkstan, African and South America -- these firms argue that these countries present low political risk (which is debatable) but Australia and Canada are almost certainly lower risk countries for mining operations.

Cameco in addition to its mining resources has three other operating segments: Fuel Services (Uranium Enrichment -- Cameco owns 3 enrichment plants: 1 pure enrichment plant, 1 uranium refinery and 1 uranium conversion plant in Canada, Canada's only enrichment capacity), Electricity (Cameco owns approximately 31% of a nuclear power plant in Canada), and Gold (owns 52% of Centerra, a public Gold Co - market cap of $C2.4Bn at 4/07, 11.5 M ou gold measured & inferred). These segments exist in addition to CCJ's uranium mining segment.

Comparisons between Cameco and ERA should take into account that Uranium Mining only accounts for 23% of Cameco's 2006 earnings before taxes. Although note that the relatively low amount is due to contracted prices of Uranium -- average realized price by Cameco in 2006 for U308 sales between $30-60, rising by quarter over the year. 2006 profitability of all 4 of CCJ's segments is as follows:

$C Uranium Mining Fuel Services Electricity Gold Mining
Revenue $803.3M $224.1M $407.6M $414M
% of total Rev 43.9% 12.2% 22.4% 22.5%

EBT $80.9M $21.6M $143.1M $91.5M
% of total EBT 23.4% 6.3% 41.4% 26.5%

BHP and Uranium -- It is Difficult to Buy BHP Only for the Uranium Exposure

Will uranium make a significant impact on BHP's bottom line going forward? BHP is a huge company, with its Base Metals Segment -- in which Uranium production is only a part (and base metals is one of seven BHP operating segments) -- contributing 34% to 2006 sales and 35% to 2006 EBIT. BHP's share of Olympic Dam is 4,000 tonnes annually and is growing, so at $100 lb Uranium, this works out to be approximately $800 to $1000M annually. BHP total revenues in 2006 were $32.2Bn and EBIT in 2006 was $15.2Bn. Assuming a 50% EBIT margin, Uranium would only contribute 2.7% to BHP's total sales and 3.3% to EBIT. In conclusion, Uranium at BHP is too small to really make an impact unless one sees extremely high prices for uranium or outstanding, 100% growth in mine production, which is not too likely to occur (and even then it is better to buy a more pure play Uranium miner).

Significance of the Low Number of Investable Uranium Companies:

Asa a final note the limited number of names can translate that if a mutual fund or other investment firm wants exposure to the Uranium sector, there are only a few stocks to invest in -- which may mean (and/or means currently) a lot of funds chasing the few quality names -- large demand, limited supply, good conditions for continued stock appreciation.

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