Smart energy investors pay attention when Dundee Capital Markets' David A.
Talbot speaks. With decades of experience as a geologist and financial
analyst, Talbot knows his game. He puts his muddy boots on the ground, always
visiting a mine before recommending a buy. In a wide-ranging interview with The Energy Report,
Talbot opens Dundee's basket of well-positioned uranium mining firms—all
well-managed companies that will pump out riches as the uranium price
stabilizes.
The Energy Report: Due to the low-priced uranium regime,
Dundee recommends that investors play defense and stick to high-grade
producers. Why?
David Talbot: Uranium prices are fluctuating around US$40 per pound
(US$40/lb). Price instability is tied to the question of when the
Japanese reactors will restart, how many will restart, and, on a
global scale, how fast reactors now on the drawing board can be built.
In this atmosphere of perennial uncertainty, the uranium producers are
outperforming the developers and the explorers, so we advise investors to
watch for names that are leveraged to rising prices. If uranium prices head
toward US$65/lb, as they should, these names will benefit tremendously. The
short story on defense is that investors should buy well-managed miners with
strong balance sheets, good access to capital and the highest quality assets.
TER: Which companies do you think fit these criteria?
DT: Wise uranium investors are looking at U.S.-based ISR [in situ
recovery] companies and high-grade explorers in the Athabasca Basin. The
newest world-class discoveries are not necessarily dependent on short-term
price fluctuations. One of our top defensive picks is Uranium
Participation Corp. (U:TSX). We have a Buy rating, with a CA$6.80/share
target price, on Uranium Participation. We have a Buy rating on Cameco Corp.
(CCO:TSX; CCJ:NYSE), with a CA$23.50/share target. We have a Buy rating
on Denison
Mines Corp. (DML:TSX; DNN:NYSE.MKT), with a CA$2.10/share target price.
And a Buy rating on NexGen Energy Ltd. (NXE:TSX.V), with no target price.
TER: Do you have a time frame for the uranium price point to hit
US$65/lb?
DT: The price could reach US$65/lb within two years. Some mines
will be very profitable at US$65/lb, but the capital markets need more
immediate incentive. Right now, uranium investors are happy staying in the
Athabasca Basin or in the western and southwestern U.S. Developing the large
deposits in Africa will require higher uranium prices.
TER: What are the possible catalysts for a resurgence in uranium?
What are the risks?
DT: I think a number of catalysts may either positively or
negatively affect uranium prices.
On the negative side, the risks are that we actually have ample spot
supply, and that there is short-term utility malaise.
Underfeeding is also important—as long as there is excess enrichment
capacity, and the centrifuges continue to spin, we might see unplanned
uranium hitting the markets, anywhere from 10–25 million pounds (10–25 Mlb)
annually.
There is also the ongoing uncertainty of excess U.S. Department of Energy
inventory sales—at least until the lawsuit by ConverDyn (private) has been
settled. The next court date is in May.
Low oil prices aren't likely to make much of an impact on uranium—perhaps
a little on cost of production, although open-pit mining isn't really much of
a uranium source.
Low natural gas prices may delay some U.S. incentive for nuclear build,
but most people are looking at growth in emerging markets anyway.
On the positive side, we have several catalysts. First is the Olympic Dam
mill shutdown and the fire at the Rössing uranium mine. A mill shutdown due
to electrical failure at the largest of three operating mills at Olympic Dam
threatens 3–4 Mlb of global uranium supply in 2015 (~10% of spot demand).
Details are still emerging from a fire at Rössing's product recovery plant,
but mining/production appears unharmed (5.2 Mlb per annum).
Second is Russia/Ukraine fallout. With ongoing strife in the region,
concerns about European Union/U.S. sanctions against Russia continue. This
could impact both primary and secondary supply, enrichment capabilities and
potentially banks that deal in the sector.
Russia, in general, is very aggressive. The country is working hard to
become the one-stop shop for nuclear power: finance and build the reactors,
supply and enrich the uranium, recover it at the end of the day. The Russians
have a contract book of more than $100 billion, and have recently signed
deals with Jordan and India, etc.
The third catalyst is Japanese restarts. We remain cautiously optimistic
on restarts of the two Sendai reactors receiving Nuclear Regulation Authority
and community approvals. It is possible the restarts are being pushed back to
August—that would be 13 months after they received approvals. Two Takahama
reactors have also received approvals, with restarts expected later this
year, But if those restarts take as long as Sendai, then we might see them
pushed into next year. Japan is a psychological driver—not a really demand
catalyst at this stage.
A fifth catalyst is Chinese resurgence. Three reactors were completed in
2014, but no new reactors broke ground until recently. Resurgence is now
expected, with five reactors expected to start construction. Expect
aggressive U3O8 procurement to continue. China comprises about 40% of the
reactors under construction globally right now. In total, 26 reactors are
being built, and by 2020, China could have about 14% of world nuclear
generation capacity, up from about 6% now. And with that, we would expect its
demand to increase to about, let's say, 32 Mlb from about 21 Mlb
currently—and that has a chance to double again, to about 64 Mlb by 2030.
China is a huge driver here.
India is also, potentially, a large driver. There are 21 reactors in use
and six under construction, but the planned reactors are in third as far as
growth, only behind China and Russia. It looks like the industry is setting
up accident insurance policies in an effort to cope with the nuclear
liabilities laws that are in place. This should help kick-start a resurgence
of build in India.
TER: Is now a good time for investors to buy into the industry
leaders such as Cameco?
DT: We are cautious on Cameco, even though we do maintain a buy
rating. Regardless of the looming tax-related issues, Cameco remains the only
real blue-chip uranium stock in the sector. Its multiples are larger than any
other company's. It trades well. It is typically a first mover in a rising
price environment. It has large, low-cost, world-class assets and the two
best uranium mines in the world, McArthur River and Cigar Lake. That said, we
are mindful of the ongoing Canada Revenue Agency (CRA) tax issue and, in the
United States, the Internal Revenue Service (IRS) investigation.
TER: What is Cameco's potential exposure in the tax issues?
DT: Cameco could be on the hook for up to CA$1.5–2 billion in cash
taxes and tax penalties for the next several years to the CRA. And another
CA$120M in fees to the IRS, by our estimate. Nonetheless, Cameco is
performing strongly, with up to 33 Mlb in sales. The company is selling in
the US$45–50/lb U3O8 range, which is much higher than the spot, which is
sub-US$40/lb. Cameco's cash costs are quite low, at around US$20–25/lb. Its
mines are performing well. And this is the year that Cigar Lake gets its feet
wet. Cameco looks to be a sustainable, high-volume producer.
TER: Any other industry leaders in your scope?
DT: Denison is an industry leader and one of our favorite stocks.
It is trading near a 3.5-year low in the market, and it is poised for
tremendous growth. It has the largest land package in the Athabasca, stocked
with high-grade resources. It has a large exploration budget, proximity to
infrastructure, and is backed by a strategic interest at the McClean Lake
mill. It has minor toll milling cash flow. Its flagship project is Wheeler
River, located midway between McArthur River mine and the Key Lake mill. The
Wheeler River project is up to 72 Mlb, grading at 19% U3O8, which makes it
the highest-grade uranium deposit in the world. Denison's Gryphon project
keeps growing in size, with room to find uranium both at the unconformity and
within the basement. Denison has CA$32M in cash to fund exploration. We are
real bulls on Denison—both short and long term.
TER: Is there a danger of discovering too much uranium in the
current price environment?
DT: The danger is not in finding too much uranium—there is plenty
around already. Whether the discovered metal makes it to market is the big
question. We had a strong run in the uranium space from 2005 through
Fukushima. But even with rising uranium prices, the only projects that came
online during that period were the two big Paladin mines, a few smaller ISR
operations scattered in the western U.S., and Cigar Lake. Interestingly,
Kazakhstan has enjoyed 90% of all new production during the past decade.
TER: What other uranium developers do you like in the Athabasca?
DT: NexGen has a dominant land package in the Athabasca Basin. It
is well liked, well followed, and nicely cashed up. It has the Arrow and Bow
projects, which are two of the most exciting new discoveries in the sector.
Drilling this winter on nine holes increased the size of Arrow by a factor
of four. The entire package measures 550 meters (550m) east/west and 250m
north/south. Two parallel shears—A2 and A3—extend for a combined 760m
vertically, averaging 80m along strike. Thicknesses are in the 20–40m range.
The Bow Zone is about 3.7 kilometers (3.7km) to the northeast of Arrow. Its
mineralization is a bit narrow, but photographs of the core look
exceptionally good. The discovery holes at Arrow and Bow actually look better
in person than on paper. NexGen will be busy drilling for the rest of the
year.
UEX
Corp. (UEX:TSX) has a couple of world-class projects in the Athabasca
Basin. We have a neutral rating and a CA$0.70/share target on UEX. Its Shea
Creek project has a 96 Mlb U3O8 resource. UEX owns 49% of Shea Creek. It also
owns 39 Mlb at its Hidden Bay project. The two UEX projects have particular
challenges, which could mean either higher capital or operating costs.
UEX historically trades well on positive exploration news, and that could
still be the case going forward. There is brownfield exploration underway at
Hidden Bay, close to Cameco's Rabbit Lake mill. There has been significant
work on this property in the past, but it has not yet been tested for the
type of basement deposits that keep extending the life of the Eagle Point
Mine. UEX's CEO, Roger Lemaitre, helped discover much of the basement
mineralization at Eagle Point when he was with Cameco. At Hidden Bay, almost
all previous exploration was focused on the upper deposits, and the basement
rocks were ignored. Roger is trying to change that.
TER: Is there a price below which it's no longer feasible to mine
in the Athabasca?
DT: That's a hard question if you count projects that have not yet
been brought into production. For existing stories, like Cameco's McArthur
River project, the cost of production is in the US$19–20/lb U3O8 range. A lot
of the capital has already been sunk. Cigar Lake, on the other hand, still
has a very low production rate, and we expect costs to be higher starting
out. Cameco keeps individual mine operating costs close to its chest, but
Rabbit Lake appears to be making money. Cameco is selling uranium at a good
premium in this market, with sales around US$45–50/lb. Its costs are probably
less than half of that price point.
TER: Energy Fuels Inc. (EFR:TSX; UUUU:NYSE.MKT; EFRFF:OTCQX)
recently merged with Uranerz Energy Corp. (URZ:TSX; URZ:NYSE.MKT) What is the
synergy in that move?
DT: We have a Buy rating and a CA$9/share target price on Energy
Fuels. This is a pro forma target that includes its Uranerz Energy purchase,
although that deal will probably close in mid-year.
We believe that the Uranerz merger will strengthen Energy Fuels. It should
have a stronger ISR production profile and lower average operating costs.
Energy Fuels also holds high-value contracts that help insulate it from lower
uranium prices. The larger, better capitalized firm that will emerge from the
deal should have a good chance of financing completion of the Nichols Ranch
ISR plant and funding Energy Fuels' Sheep Mountain and Roca Honda pipeline
projects. We estimate that about 50% of the company's net asset value (NAV)
is locked up in the two pipeline assets alone.
Energy Fuels' 8.8 Mlb uranium inventory is worth about US$28M. This
product is ready to be sold into beefed-up contracts that Uranerz holds, or into
the spot market. Energy Fuels' total uranium resource is 150 Mlb U3O8, which
makes its resource base the largest among producers in the U.S. With its
pipeline projects, Energy Fuels could ultimately surpass Cameco's U.S.
production rate.
TER: How does the term price affect spot for uranium concentrates?
DT: The term price for uranium has held at US$49/lb for a while,
despite a fluctuating spot price. Investors typically focus on spot
fluctuations as a gauge for market sentiment. But most utility requirements
are in the term market.
Term prices should therefore be considered the better gauge of utility
demand. Rising term prices mean increased contracting, which should be
bullish for the equities. We typically see a US$10/lb spread between term and
spot prices. Any tightening of that spread could be a leading indicator for
higher term prices. With 80 Mlb of term volume traded over the last two
years, we assess that term contracting will accelerate to offset the nearly
360 Mlb of uranium used in nuclear reactors over the same period.
TER: Do you have a pick in the uranium concentrate, or U3O8 space?
DT: U3O8 is the end product of all the mines, but if we discuss a
company that accumulates uranium, then we would talk about Uranium
Participation. We have a Buy rating and CA$6.80/share target price for this
stock. And, as we mentioned earlier, it is a defensive name. This firm allows
investors to purchase the pure commodity itself, and potentially benefit from
expected rising prices. Investors need not worry about permitting,
production, technical risks or jurisdiction risks. The company's modus
operandi is to raise money, buy uranium in the market and watch the price
rise. The NAV goes up as the underlying value goes up.
Last year, Uranium Participation signaled that it is coming to market with
a $200M shelf prospectus. Unfortunately, Uranium Participation is now trading
at a 12% discount to its underlying NAV, after trading at a premium for most
of last year—a positive sentiment signal by investors. Either people do not
believe that uranium prices will rise, which we don't believe to be the case,
or they are waiting for something special to happen. We are fairly sure that
the company will not raise money in discount territory. Therefore, we see
this as a good entry point. Investors could benefit from both rising uranium
prices and the company's potential rise from a discount to typical premium
valuation with respect to its NAV.
TER: You also analyze graphite for Dundee. Any picks?
DT: We are seeing renewed interest in the graphite sector. The
rumor that Apple will be building batteries for a driverless car has excited
the market. Tesla remains a key topic of conversation. Graphite demand could
grow at near double-digit rates, about 9% per year into the next decade.
Future demand will be powered primarily by the manufacture of electric
vehicle batteries. We also see stable growth coming from historical
industrial applications, such as refractories and crucibles. Graphite supply
is 80% concentrated in China. Current demand is 1.2M tons per year, but
supply exceeds demand by 200,000 tons. That picture is set to change. It will
require two to three sizeable mines to maintain a stable supply balance going
forward.
There are wildcards, of course, like Tesla
Motors Inc.'s (TSLA:NASDAQ) proposed Gigafactory. Graphite mine shutdowns
in China due to pollution could pressure the supply/demand picture. It is
worth noting that very few public companies operate graphite mines. But late
last year we launched coverage on three graphite names. We have a Buy rating
and a CA$0.90/share target on our top pick, Mason Graphite
Inc. (LLG:TSX.V; MGPHF:OTCQX). We have a Buy rating and a CA$0.60/share
target on Focus
Graphite Inc. (FMS:TSX.V; FCSMF:OTCQX; FKC:FSE), and a Buy rating and a
CA$0.40/share target on Energizer Resources Inc. (EGZ:TSX.V; ENZR:OTCQX). It is
our expectation that financing is key to which graphite companies survive,
and that first to market is an important factor.
TER: Please explain the reasons investors should look at these
companies.
DT: Mason is nicely funded. It has an extensive following and
investments in three well-known Québec-based institutions. It owns 100% of
the Lac Guéret project in Québec, which is among the highest-grade projects
in the world. Early metallurgical work demonstrates about 90% of recovery
there. The deposit is 100% flake, which is the required product for end users
looking to use graphite for lithium-ion batteries and other high-tech
applications. The project is about 80km from an all-weather road, and 290km
north of Baie-Comeau, a port city in Québec. Mason's management has extensive
knowledge of the market and numerous relationships with buyers. While Mason's
is not the most advanced project in the graphite space, of the three
companies that we cover, we view it as having the best chance of being
financed.
Focus Graphite owns the Lac Knife project in Québec, located within an
established iron ore camp, near roads, rail, a port and a labor force. Lac
Knife is a large, well-advanced, high-purity project with nice size
distribution and quality management. It is one of few graphite companies with
an offtake. It has demonstrated that coated spherical graphite from its
project shows superior electrochemical performance when compared with
commercial grades of synthetic graphite for lithium-ion batteries. The firm's
President and CEO, Donald Baxter, brings production experience from serving
as director of mining at Ontario Graphite. The company is actively seeking
financing for the project.
Energizer Resources has a 75% ownership interest in the Molo project in
Madagascar. This project is predominantly large and jumbo flake, and it looks
easy to mine at the surface. We see a potential for offtake that could
expedite the big project financing required to develop Molo.
Madagascar remains relatively unknown to investors and poses a challenge
to those seeking equity capital. But Energizer's location situates it well
for quick and low-cost shipments to Asia. Energizer could lean more on the
strategic alliance with end users. But the product stands up well in testing,
meeting all the requirements for a variety of uses. A recent feasibility
study provided good improvement over the two-year drill program. The study
sets up the company for a potential project financing within in the next six
months.
TER: Do you visit these mines?
DT: Yes, I have visited several graphite, lithium and iron ore
projects, plus about 85 uranium projects worldwide. I am a geologist with
almost 10 years' experience in the gold exploration industry. With this
background, we believe that we are able to quickly sight early-stage
opportunities in these sectors—it's one of Dundee's sweet spots. We
understand the geological environments, technologies, underlying risks and
opportunities.
TER: David, thanks for your time.
Dundee Capital Markets Vice President and
Senior Mining Analyst David A. Talbot worked for nine years as a geologist in
the gold exploration industry in northern Ontario with Placer Dome,
Franco-Nevada and Newmont Capital. Talbot joined Dundee's research department
in May 2003, and in the summer of 2007, he took over the role of analyzing
the fast-growing uranium sector, and currently covers uranium, lithium,
graphite and iron ore. Talbot is a member of the Prospectors and Developers
Association of Canada (PDAC), the Society of Economic Geologists (SEG) and
graduated with distinction from the University of Western Ontario with an
Honours B.Sc. degree in geology.