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Analyst David
Sadowski of Raymond James sees a lot on the horizon for uranium: a supply
shortfall, escalating Asian demand and seasonality, to name just a few. As a
former geologist-turned sellside analyst, Sadowski's conviction in uranium's
bullish future is rock solid, and he urges investors to get exposure now, as
prices in this sector can climb quickly once they're set in motion. In this
exclusive interview with The
Energy Report, Sadowski shares his favorite
names that are set to deliver megawatt-size returns to investors.
The Energy
Report: David, how does your background as a geologist help
you to see value and growth potential in mining companies?
David Sadowski:
Defining ounces or pounds is not an easy business.
If it was, there would certainly be far more economic deposits out there and
metal prices would be a lot lower. Luck is involved, but most companies use
systematic evaluations like geological surveys, drilling and other data to
take a lot of the guesswork out of finding the next discovery. The ability to
interpret these data is equally important, and it allows an analyst to make
an independent determination on the growth potential of a project rather than
just relying on what management is saying. In this way, I feel like having an
understanding of how economic ore deposits form is essential to developing a
meaningful forward-looking opinion, particularly on early-stage prospects. In
my view that's one of the most important tools for the successful analyst.
TER:
You're also clearly comfortable speaking with engineers and geologists at
these companies.
DS:
Yes, quite right. That's a very important element to my role. You have to be
able to speak the same language and understand what they're doing on the
ground, and that helps the analyst determine whether or not the company is
headed in the right direction. It's a key skill to have.
TER: I
was also very curious about your transition to finance as a sellside analyst.
You once had a responsibility to the companies for which you worked, but now
your stakeholders are institutional and retail investors. What mental shifts
did you have to make?
"We're definitely bullish on the outlook for
uranium."
DS: As
an exploration geologist, one is really focused on the rocks, sometimes even
at the microscopic level, and that's a much different scope of focus than
that of a mining analyst. The financial and operational outlook for the
company and its share price must always be on the analyst's mind, and we're
not looking at companies in isolation, as a geologist might do. If you're in
the business of projecting where the commodity price is going, as I am for
uranium, the scope of analysis is global and extends from government policy
right down to whether we think a specific ore zone will be amenable to heap
leach, for example. As you mentioned, first and foremost I look out for the
interest of investors rather than the mining companies, and this
responsibility demands even higher levels of objectivity, precision and
rigor. It's a constant challenge and that makes it an exciting and fulfilling
role.
TER:
Speaking of forecasts, uranium has dipped below the $50/lb level. I'm not
sure, but I think these round numbers represent psychological support and
resistance levels. What minimum price level must be sustained for small or
near-term producers to maintain adequate margins?
DS:
Well, if we look at existing operations, the majority of them would be losing
money by selling their material at $40/lb. But there are a few exceptions,
some of which are quite large producers, like Cameco
Corp.'s (CCO:TSX; CCJ:NYSE) McArthur River
or BHP Billiton Ltd.'s (BHP:NYSE;
BHPLF:OTCPK) Olympic Dam. By our estimates, the only two
potential projects that are likely to work in the $40/lb range of average
realized price would likely be Cigar Lake and the expansion at Olympic Dam,
but these are definitely major outliers. Cigar Lake is the second-highest
grading deposit in the world, and it's located in an excellent jurisdiction
in northern Saskatchewan with significant existing infrastructure nearby.
Meanwhile, Olympic Dam only works at that price because its uranium
production is a byproduct of much more significant gold and copper output.
When we look at the majority of additional projects needed to fill the
looming supply gap, we think they need prices north of $70/lb to go forward.
This is one of the key reasons why we feel the sub-$50/lb prices are
unsustainable.
TER:
What is your case for rising demand for uranium?
DS:
We're definitely bullish on the outlook for uranium. Although prices have
softened in recent months, we have a very strong conviction that this trend
is soon to reverse and investors should be exposed to uranium today. Beyond
the high incentive prices for new supply that we just touched on, there are
three primary reasons for our view. The first one is compelling supply/demand
fundamentals. Next, there is the seasonality of uranium prices. And, most
importantly, there are industry catalysts. Shall we take a look at each one?
TER:
Please, go right ahead.
DS: After
the Fukushima Daiichi accident last year, the nuclear industry has done some
soul searching and decided to take a slower, more cautious pace in the
construction of new reactors globally. But what many people don't realize is
that according to World Nuclear Association (WNA) data, there are nine more
reactors in the planned and proposed category today than there were before
the accident. Demand for nuclear power has remained resilient with ramping
electricity requirements around the world, volatility in fossil fuel prices,
energy supply security concerns and a global preference for carbon-neutral
sources. The majority of this demand is from Asia. In fact, we estimate 82%
of new capacity through 2020 will be built in only four
countries—China, India, Russia and South Korea. Part of the reason for
that is that state-owned utilities don't face the same problems associated
with other regions, like high upfront construction costs, widespread
antinuclear public sentiment and lengthy regulatory timelines. So, this
continued growth should support commensurate levels of demand for uranium for
decades to come.
"Demand for nuclear power has remained
resilient with ramping electricity requirements around the world, volatility
in fossil fuel prices, energy supply security concerns and a global
preference for carbon-neutral sources."
All of this
demand begs the question, where is this uranium going to come from? Well, we
don't think supply is going to be able to keep up. Due to recent soft prices,
many major projects have been delayed or shelved, like BHP's Olympic Dam
expansion, which I mentioned earlier, and Cameco's Kintyre project, AREVA's (AREVA:EPA)
Trekkopje project and the stage 4 expansion at Paladin
Energy Ltd.'s (PDN:TSX; PDN:ASX) Langer
Heinrich mine. Even the world's largest producer, Kazakhstan, may slow its
pace of production growth. And, further complicating this issue is dwindling
secondary supplies, like surplus government stockpiles, which in recent years
have contributed 50 million pounds (Mlb)/year. But, that number is expected
to halve over the next few years. We are projecting a three-year supply
shortfall starting in 2014, and that certainly paints a very rosy
supply/demand picture for investors.
Seasonality
also favors uranium exposure today. Over the last 10 years, uranium spot
prices have dropped on average $4/lb during the third quarter (Q3) but have
rebounded by at least that amount in Q4, which is the strongest quarter of
the year. This is often correlated with the annual WNA symposium, where many
market participants sit down and hammer out new supply agreements. This
year's conference is going to be held September 12–14 in London.
Last but not
least, there are several near-term catalysts that we think will start the
price upswing. In Japan, all but two reactors are now offline, and there's
significant uncertainty and government debate about how many will eventually
restart. As the world's third-largest nuclear fleet, it has obvious
implications for future uranium demand. For a variety of economic, political
and environmental reasons, we think Japan will restart most of its reactors
by 2017 with the first batch of reactors likely starting early in 2013. As
more units start to return to service, it will provide additional confidence
that the nuclear utilities in Japan are unlikely to dump their inventories
into the market, which should support prices in the near-term.
Meanwhile in
China, the government paused construction approvals for new reactors
immediately after last year's Fukushima accident. But with these safety
reviews now successfully completed, they're poised to start re-permitting new
projects, and this should undoubtedly support increased uranium contracting.
Let's not forget that China will be far-and-away the largest source of
nuclear demand growth for the foreseeable future. We expect a six-fold
increase in installed nuclear capacity by the end of this decade.
The final major
catalyst is the expiry of the Russian Highly Enriched Uranium (HEU) agreement
to down-blend material from nuclear warheads into reactor fuel. This
agreement has supplied the Western World for two decades but is due to
conclude at the end of 2013. The Russians have repeatedly stated they're not
interested in extending this agreement, and we expect this to remove about 24
Mlbs/year or 13% from the global supply. That's equivalent to shutting down
the world's largest mine, McArthur River, as well as all six operating mines
in the U.S. That's a massive impact. So, for these reasons we think prices
are poised to turn here. We forecast prices to average above $60/lb in 2013
and north of $70/lb in 2014 and 2015 before settling to $70/lb in the
long-term.
TER:
These catalysts are spread out over the next 18 months, which is not a long
time. Stock markets generally look ahead. So, why are prices lagging as they
are?
DS:
That's a good question. I think what we're seeing is a significant amount of
uncertainty in the marketplace surrounding the availability of some material
and who is going to be a near-term buyer. The purchasing side is largely
comprised of nuclear utilities, which are usually very conservative and
cautious. Based on our experience, they tend not to make rash moves and
prefer to wait until all information is available before jumping into new
sales contracts. For instance, they would rather have certainty on whether
utilities in Japan and Germany are going to be selling any of their
inventories before they start buying. This has led to very low volumes in
recent months.
However, we're
already starting to see contracting activity pick up with major long-term
deals signed by Paladin and one with the United Arab Emirates, both this
month. And the WNA meetings are now only a few weeks away. This mounting
activity could be just what the market needs for the metal price to shift to
higher and more sustainable levels. And recent history shows that when the
price moves, it can move really quickly as we saw in 2007, mid-2009 and
late-2010 when the weekly uranium spot price jumped in increments of
$5–10/lb.
TER:
Could these current low prices force juniors to sell themselves to the larger
companies, the producers?
DS:
Well, we certainly expect further consolidation in the space. This industry
is pretty much divided into the haves and have-nots. On one side we have
state-owned utilities in countries like China and Korea, which essentially
have zero cost of capital and the stated intention to build their exposure to
uranium production. We also have large producers, like Cameco and Uranium One Inc. (UUU:TSX),
that are cashed up and looking to grow. But, meanwhile many have-not
companies have been under significant pressure in this current low uranium
price environment with weak balance sheets and share prices. They could be
looking to either sell assets or be taken over completely. Last year we saw
Hathor get acquired by Rio Tinto Plc (RIO:NYSE; RIO:ASX;
RIO:LSE; RTPPF:OTCPK). Extract Resources was bought by
the Chinese nuclear utility, China Guangdong Nuclear Power Corp. (CGNPC).
And, Mantra Resources was just purchased by Russia's ARMZ Uranium Holding Co.
These major deals could just be the start of another major trend of M&A
in our view.
TER: I'm
surprised that those acquisitions you just mentioned haven't been a bullish
signal to the market.
DS: We definitely think that
they're a bullish signal. It means that the larger companies are willing to
lay out capital and put it at risk to build their future pipelines, which is
a sign to us that they have confidence in where the uranium price is going
and that they want to have higher production in the future to take advantage
of those higher prices.
TER:
David, everything you have said sounds to me like you believe that we are now
in a legitimate value market in uranium equities. Is that the way you feel?
DS: Yes,
definitely.
TER:
What are your best ideas that you're telling investors about?
DS: We
prefer higher-quality, lower-risk names with minimal capital requirements.
One of those is Cameco. It's the world's largest publicly listed uranium
producer. Its market cap is over $8 billion (B). So that makes it very
acceptable for many investors who have certain constraints and mandates to
get exposure to the uranium space. It's historically been the go-to name in
the space. This company features strong production growth and a very low
production cost. And it's got a critical milestone coming up with the startup
of its massive 50%-owned Cigar Lake project, which is due to come on-stream
in late 2013. When fully ramped up, Cigar Lake is going to be the
second-largest mine in the world. Cameco also has a very healthy balance
sheet with access to about $4B in capital, and we wouldn't be surprised if it
puts that money to work by making an acquisition in the next 6–12
months.
TER: You
have a $28 target price on Cameco, which does not represent huge upside gain
from current levels. Is this what you think of as a safer, more conservative
play?
DS:
Yes, certainly. It reduces your risk via diversification into the other parts
of the fuel cycle, such as conversion, refining and electricity generation,
while you're still getting some serious exposure to the uranium space. Even
if we don't project a really big return to our target, we think it's a safe
play and we recommend it. There's less volatility in this one.
TER:
What's your next idea?
DS: The
next one in terms of lower-risk names we'd recommend is Uranium Participation Corp.
(U:TSX). Our target is $8, but we've got a Strong Buy on it
because we think this is a great low-risk way to get into the space. It's the
world's only physical uranium fund, and it's designed to give investors
pure-play exposure to the uranium price without any of the associated
exploration, development or mining risks. The fund usually trades at slight
premium to its net asset value (NAV), but currently it's about 13% below NAV.
We think it's trading at a great entry point right now. Its current share
price implies a uranium price of about $44/lb. If you're like us and you
think spot prices are unlikely to descend to those levels, then Uranium
Participation offers good value today. If you're an investor looking for more
leverage, it may not be the one for you. But, I think if you're going to buy
a basket of equities this is one that you may want to include.
TER:
What about investors who are willing to take on a bit more risk for greater
returns?
DS: If
you want more leveraged exposure to a potential spot-price rebound, we would
consider a couple of other companies. The first one is Ur-Energy Inc. (URE:TSX;
URG:NYSE.A), and we've got a $1.80 target and a Strong Buy
rating on this one as well. It's got an excellent flagship project called
Lost Creek in mining-friendly Wyoming. We see production starting up there in
the second half of next year. The project's got low capital and operating
costs and it's scalable as well. Despite a somewhat small 1 Mlb/yr mine plan,
the design of the backend of the Lost Creek plant should accommodate about 2
Mlb/year of uranium. It should be able to incorporate other satellite
deposits, such as those acquired from Uranium One earlier this year as well
as from Areva last month. Ur-Energy is also a catalyst story. It's got only
one final mine permit required before construction can start, and we have
strong conviction that final approvals from the Bureau of Land Management
(BLM) will come in by the end of September, particularly following release of
the Final Environmental Impact Statement (EIS) last week—a major
milestone. Currently Ur-Energy's valuation is very attractive, trading at the
lowest price/NAV (0.5x) of any of our covered equities, and we think receipt
of that approval from the BLM could help close the gap towards developer
valuations.
TER:
Over the past four weeks it's up 34%. I'm guessing that the near-term
expectation of this BLM permit is the reason for this stock's very high
relative strength.
DS: I
think so. I think we're trending towards that date, and it's become very
important because this company has faced a little bit of difficulty over the
last few years with some of its permitting timelines. It has missed a few
targets, and that has really hurt the share price. And, yes, when this permit
comes in we think it should be a great catalyst for the stock to re-rate
towards developer valuations.
TER:
Would you mention another name?
DS:
Uranium One is another one of these stocks with a bit higher risk profile,
but we think this risk is justified, and that is demonstrated by our higher
target price. We are rating it Outperform with a $3.60 target. It's got an
excellent suite of low-cost in situ leach mines in Kazakhstan. It's the
world's fourth-largest producer, and it's also one of the fastest-growing
producers out there as well. We modeled over 15 Mlb of production in 2015, up
from only 10.7 Mlbs in 2011. Uranium One has the highest exposure to spot
prices than any other company in our coverage universe, so it's a great way
to play this space if you're a strong believer in uranium prices going
upwards. Uranium One is 52% owned by ARMZ Uranium Holding Co., a strong partner,
and that's allowed it to access the Russian ruble bond market, which has been
a boon for the company. It's at a great entry point at current levels, with a
0.7x current price/NAV.
TER:
David, Uranium One has a $2.3B market cap, and because of that there are a
lot of mutual funds that could buy this stock. But it strikes me that its
market value is a quarter the size of Cameco. Mutual funds could get some
very significant upside from Uranium One.
DS: That's
a really good point to make. There are very few universally investable
uranium equities. And by that I mean that there are very few publicly listed
uranium equities in Canada, for example, that exceed that $1B market-cap
threshold. Cameco is the biggest one at over $8B in market cap, and then
you've got Uranium One, and Paladin Energy. And, beyond that there are very
few places that you can put your money if you're the type of investor that's
got the specific size and liquidity constraints or mandates, like you said,
as a mutual fund. Those are pretty much the top three go-to places if you
want uranium exposure.
TER: Is
there one more you could mention? You have a Market Perform rating on Denison Mines Corp. (DML:TSX;
DNN:NYSE.A). I'm interested in hearing about it because the
company is once again an explorer.
DS:
Denison Mines has a great management group lead by Ron Hochstein, and it has
a 60%-interest in an excellent exploration project called Wheeler River,
which is one of the best discoveries that we've seen in about a decade,
perhaps trailing only Hathor's Roughrider. It's also one of the
highest-grading uranium deposits that has ever been discovered. We think that
the project could nearly double its resources at depth, along strike and on
regional targets, and so we model 70 Mlbs at 12% target resources at Wheeler
River. Denison also has a 22.5% ownership of the state-of-the-art JEB mill,
which is one of only four active conventional uranium mills in North America.
It's unique in that it can process high-grade ores without having to
downblend. That's a strong competitive advantage. For those reasons, we think
Denison is a good takeout target. Cameco and Rio Tinto's faceoff for Hathor
last year was probably their first battle in a larger war for the prime
assets in the basin, and Denison has two of them. That said, we are cautious
on the name today given limited visibility to production at its minority-held
Canadian projects and in Mongolia and Zambia, as well as potential financing
risk next year. We have a Market Perform rating and $1.80 target on the
company.
TER: I
have enjoyed meeting you very much, David.
DS:
Thanks for having me George. It was a pleasure to speak with you as well.
David
Sadowski has been a member of Raymond James' mining team
since June 2008, and now covers the uranium and junior precious metal spaces
as a research analyst. Prior to joining the firm, David worked as a geologist
in Central and Northern B.C. with multiple Vancouver-based junior exploration
companies, focused on base and precious metals. David holds a Bachelor of
Science in Geological Sciences from the University of British Columbia.
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DISCLOSURE:
1) George S. Mack of The
Energy Report conducted this interview. He personally and/or his
family own shares of the following companies mentioned in this interview:
None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Ur-Energy
Inc. Streetwise Reports does not accept stock in exchange for services.
Interviews are edited for clarity.
3) David Sadowski: I personally and/or my family own shares of the following
companies mentioned in this interview: None. I personally and/or my family is
paid by the following companies mentioned in this interview: None. I was not
paid by Streetwise Reports for participating in this story.
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