The Fukushima disaster cast a shadow on the uranium mining industry, but in this exclusive interview, David A. Talbot, Dundee Capital Markets Vice President and Senior Mining Analyst, sees very strong fundamentals, especially in the absence of substitutes for nuclear generation. Such a premise suggests that uranium use will rise with growing populations and needs.
Companies Mentioned: AREVA - Bannerman Resources Ltd. - Extract Resources Ltd. - Fission Energy Corp. - Hathor Exploration Ltd. - Mantra Resources Ltd. - Mawson Resources Ltd. - Paladin Energy Ltd. - Rio Tinto - Rockgate Capital Corp. - UEX Corporation - Uranerz Energy Corp. - Uranium Energy Corp - Uranium One Inc.
The Energy Report: Dave, what is your post-Fukushima uranium thesis?
David Talbot: Post Fukushima, there are broader market issues that are also impacting the uranium equities. However, there is a little bit of danger that if we don't get a lot of this new build, uranium prices would increase.
TER: Lack of development would give rise to the classic market conditions that would ultimately force uranium prices up.
DT: Exactly.
TER: How does consolidation come into play?
DT: I don't think there is necessarily consolidation for its own sake. I think that there are some companies that are just so undervalued that larger companies that want to get into certain areas may jump at these opportunities. Hathor Exploration Ltd. (HAT:TSX.V) ended up being taken by Rio Tinto (RIO:NYSE; RIO:ASX; Not Rated) at almost an 80% premium to where it was trading before. The initial Cameco Corp. (CCO:TSX; CCJ:NYSE; Not Rated) offer of $3.75/share was certainly opportunistic. I'm not surprised at all that Cameco didn't win the bid at that level.
TER: Does this portend additional or future takeouts?
DT: I think we probably will see some, especially if we take a look at Canada's Athabasca Basin. Rio Tinto is the second-largest mining company in the world with a $100 billion (B) market cap and $7.5B in cash. So I don't think Rio is going into the Athabasca Basin for just 70 million pounds (Mlb) of uranium. I really think it is going to take a look at other opportunities there, first and foremost AREVA (CEI:PAR; Not Rated). AREVA has a lot of assets in the basin and it is not spending a lot of money on exploration there this year.
I think it's down to only two rigs at its Shea Creek joint venture (JV) with UEX Corporation (UEX:TSX). So I think there's potential that Rio is going to go after some of the AREVA assets. No, I don't think it will get McArthur or Cigar Lake interests, which are the two best uranium deposits in the world, but it might get something like the McClean assets. There's also the Midwest deposits, which are immediately next door to the Roughrider deposit, and it makes sense for Rio to go after that. So that's the first thing. Then there are other projects in the basin. Fission Energy Corp. (FIS:TSX.V; FSSIF:OTCQX) or UEX are potential targets as well.
TER: Will we see the double-digit returns again in the uranium industry?
DT: I think we will come back to double-digit returns. The stocks actually had double-digit returns on three occasions this summer. But Fukushima put long-term viability of the sector in doubt for some time due to significant negative press, which kept coming, and often it was just wrong. Uranium and uranium equity markets now seem to be hypersensitive to negative news, and the spot price was declining due to supply concerns earlier this year, and the stocks were trading hand-in-hand with uranium prices. We think that Fukushima ultimately is responsible for only about 30–35% of the value lost in the uranium equities while many of the stocks are down by about half.
TER: I'm hearing you say there's value in the equities because of this 35% haircut that Fukushima gave the industry, but I'm wondering about revenue lines and bottom lines.
DT: For the producers, revenue is certainly tied to uranium prices and the rate of production. I think many of the uranium producers are also ramping up production: Cameco is touting its "Double U" program, doubling its production by 2018. We forecast Paladin Energy Ltd. (PDN:TSX; PDN:ASX) production to rise almost 90% to about 13 Mlb and Uranium One Inc. (UUU:TSX) production to rise by about 75% as well over the next four years. Whether uranium prices reach the bottom line really depends on the company.
I think Cameco can be considered as almost a blue chip stock in the sector with excellent margins. On the other end of the spectrum, I think Paladin has some hefty general and administrative (G&A), exploration and financing costs that it's working to reduce. I think some companies like that actually need higher uranium prices than the $52/pound (lb) where we're trading at right now. We forecast uranium prices of between $65 and $75/lb over the next couple of years, especially once the HEU (highly enriched uranium) Agreement goes offline.
TER: What are some growth drivers in the industry?
DT: I think the main growth drivers are the expectations for higher prices given the strong fundamentals of the uranium space. We believe that demand will really outpace supply beyond 2013. Uranium demand continues to be strong. Nuclear build continues to increase despite Fukushima and despite that the reactors that are now offline in Japan and Germany. Today there are 12 more reactors in operation, under construction, planned or proposed than there were before the Fukushima incident. So that's about 997 reactors on the drawing board right now in one way, shape or form.
We have seen uranium production increase about 28% over the past four years with almost all of that growth coming from Kazakhstan and Namibia. In fact, Canada and Australia are actually in decline over the same period. So despite this big runup in uranium prices from about $20 six years ago, we really haven't seen the mine construction that we had expected. Projects have been delayed, deferred or canceled for many reasons. We are estimating maybe just under 200 Mlb of production by 2020 if everything goes forward as planned.
Another important driver is the reduction in secondary supply resulting from the HEU Agreement, the downblending of the Russian nuclear weapons program and then selling that uranium for nuclear fuel. The HEU Agreement is expected to go offline by the end of year 2013, and the Russians continue to confirm this. The end of the HEU program would remove 24 Mlb from supply annually. That number is huge. It's about 18% of all uranium mining.
I think Cameco CEO Tim Gitzel said it best on his Q311 conference call: "We absolutely believe it will happen that when the HEU agreement comes off, it will equal production from McArthur, Rabbit, Smith Ranch and Crow Butte all put together." That's about 1.4 times larger than the Cigar Lake production. So what do you think the market will do when it realizes this HEU Agreement is going offline? I think that's definitely positive for the fundamentals.
TER: Is China going to be the major global driver?
DT: Yes. I would say China is definitely the dominant growth driver. Along with India and Russia, China is going to account for about half of the new build in the world. While China has temporarily suspended approvals pending stress tests and further review in light of Fukushima, and rightly so, the country maintains strong support for nuclear power. The country is up to 15 reactors in operation from 11 just one year ago, and it has another 26 under construction, 51 planned and 120 proposed. So China is definitely leading the way.
TER: And utilities are in the game now.
DT: I think the Asian utilities are going to go out of their way to either purchase uranium in the markets through long-term contracts, but probably and most importantly, buy some of those large uranium mines around the world. This, potentially, leaves less uranium for the next country. The examples are China looking at Extract Resources Ltd. (EXT:TSX; EXT:ASX; Not Rated), the Russians buying out Mantra Resources Ltd. (MRU:TSX) on behalf of Uranium One. The Chinese were even looking at Bannerman Resources Ltd. (BAN:TSX; BMN:ASX; Not Rated). These are some of the world's largest deposits that are potentially disappearing.
TER: When you put it all together it sounds like a bullish scenario. What companies do you like?
DT: I would have to say our top pick right now is Rockgate Capital Corp. (RGT:TSX). We have it rated as a Buy with a target price of $4 per share. This company hosts a growing resource at its 100%-owned Falea project in Mali in West Africa. Right now, it has resources of 28 Mlb of triuranium octoxide (U3O8) with 41 Moz silver and some copper. So it is a polymetallic deposit. Exploration continues to extend the deposit in several directions. The assays it receives from drilling exceed the average resource grade of 0.11% uranium and 111 grams/ton (g/t) silver. The company is currently upgrading the resource area and expanding the zone in several directions.
