Dundee's David Talbot Charges Ahead, Confident that Uranium Has a Bright Future

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.