David Sadowski
is a mining equity research analyst at Raymond James, and has been
covering the uranium and junior precious metals spaces for the past
seven years. Prior to joining the firm, David worked as a geologist in
western Canada 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.
The Energy Report: David,
the uranium price remains below the cost of production for many
producers and the forecasts for uranium production are flat. Why are you
optimistic about the uranium space?
David Sadowski:
In the current price environment, supply won't be able to keep up with
demand growth. That's really the core to the uranium investment thesis.
The cost of uranium production spans a pretty wide range, from the mid-
to high-teens per pound for the cheapest in-situ leach mines in
Kazakhstan, to $50–60/pound ($50–60/lb) for some of the lower-grade,
conventional assets in Africa, Australia and East Asia. So we're looking
at about $40 to produce your average pound of uranium. That number is
climbing on cost inflation and depletion of the best mines.
The
current spot price is under $36/lb, so many operations are underwater
right now. That's why we've seen numerous deferrals of projects and even
shutdowns of existing mines, the most significant of which was Paladin Energy Ltd.'s (PDN:TSX; PDN:ASX)
Kayelekera at the beginning of February. That's on top of operations
that are at risk for other reasons. In just the last few months, we've
seen four of the world's largest mines owned by Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK) and AREVA SA (AREVA:EPA)
shut down on operational and political hiccups. Then you look at where
the supposed growth is coming from over the next several years— Cameco Corp.'s (CCO:TSX; CCJ:NYSE)
Cigar Lake and China's Husab. Those are technically very challenging,
too. All of this is occurring in a world no longer benefitting from a
steady 24 million pounds per year (24 Mlb/year) supply of uranium from
downblended Russian warheads. In short, the supply side is a basket
case.
Yet demand growth keeps chugging along. European Union (EU)
and North American growth perhaps isn't what it was a couple of decades
ago. Pressure from competing energy sources like liquefied natural gas
(LNG) in the U.S. is causing some operators to switch off their older,
smaller reactors. But reactor retirements are being more than offset by
new reactor construction not only in the U.S. and EU, but much more
important, in Asia and in Russia. China, India, Korea and Russia are
collectively constructing 70 reactors right now.
TER:
Japan and the United Arab Emirates (UAE) just announced a program to
cooperate in developing nuclear technology. What's the market
significance of that?
DS: There is a push toward
nuclear in many of these nations in the Middle East. Not only do they
have pretty strong population growth and urbanization, thus electricity
growth is strong, but some of those oil-rich nations have cited a
preference to sell their petroleum into the international markets rather
than domestically. The UAE is a very large potential source of demand
growth. It is constructing two nuclear power plants at the moment and is
imminently going to break ground on two more. There are an additional
41 new nuclear reactors on the drawing board in the Middle East. So in
the context of 434 operable reactors today, that's a very meaningful
amount of growth potential.
Demand growth remains resilient, and
supply is lagging behind. In just a few years, we think this will lead
to a deficit that will quickly grow to crisis levels. That's why we're
bullish. Uranium prices have to go higher to incentivize more supply to
meet this looming supply gap.
TER: Why hasn't that happened yet?
DS:
There are just a few forces working against the price. Since the
Fukushima accident in Japan, there has been a supply glut in the
marketplace. There has been a decrease in demand, with a lower level of
buying by some countries, like Germany, Switzerland and, of course,
Japan. Additionally, some extra supply was coming out of the U.S.
government. There is an extra amount coming from enrichment
underfeeding. If you add all that up, there has been essentially more
supply than is required, and that puts downward pressure on prices. It's
caused the utilities to take a step back from the market.
TER: So do you think conditions in the market itself will materially improve? What will that look like?
DS:
For us, it comes down to when the utilities start getting involved
again. While the utilities have been sitting on the sidelines over the
last couple of years, high-fiving each other for not buying uranium in a
declining price environment, their uncovered requirements in the future
have actually risen quite dramatically. At some point, they have to
resume long-term contracting to cover all those needs. Japan is a key
catalyst.
Japan's reactors were slowly shut down after the Fukushima accident.
Right now, none of them are operating. The country's inventories have
piled up to probably around 100 Mlb. Many of these utilities have asked
their suppliers to delay deliveries of fresh uranium. That material ends
up in the marketplace one way or another, so it's having a
price-dampening effect. In late February, however, the Japanese
government announced its final-draft energy plan. Japan will restart at
least some of its reactors to stop spending a ludicrous amount of money
on imported fossil fuels. There are other economic and environmental
benefits, but it’s the country's trade balance that is really driving
the restart push.
It's these restarts that we think will spur
global utilities outside Japan to resume buying. The signal will be sent
that Japan won't be dumping its inventories, it won't be deferring
deliveries anymore and, by the way, there is not enough supply to go
around in just a few years so you better start contracting again. That's
what we think is going to support prices.
TER:
That basic energy plan in Japan is a draft, but there is a lot of public
opinion against it. You do think its prospects are good?
DS:
Consensus is that the plan is going to be approved by the cabinet by
the end of March. The opposition is highly regionalized, and many
pockets of the country are actually very pronuclear. Nuclear, obviously,
provides a lot of jobs and generates a lot of tax revenue in these
regions.
TER: Raymond James has revised its
uranium supply-demand balance and anticipates a growing supply deficit
beginning in 2017. What is the case for investing in the industry today
with a payoff so far in the future?
DS: A
shortfall beginning in 2017 doesn't mean prices don't move until 2017.
In fact, in a healthy market, they should have moved already. But,
again, it comes back to the utilities. They view the nuclear fuel market
and their own fuel requirements as a game of risk management.
"I'm very hopeful that UEX Corp.'s new CEO will continue the company's trend of excellent work."
Today,
many utilities are sitting on near-record piles of material, so there's
not a great deal of risk to the utilities with respect to supply
availability over the next couple of years. However, as these groups
start to look out beyond that period to 2017, 2018 and so on, they'll
realize that it could become more challenging to get the uranium they
need. Given that the utilities typically contract three to four years in
advance, we're very close to that window where we expect buying to ramp
up again and prices to move upward. Again, critically, we expect
Japanese restarts to be an important catalyst in that resumption of
buying. We expect first restarts in H2/14 with a half-dozen units online
by Christmas. So from an investor's point of view, we're already seeing
the benefit of this outlook. That's been driving the uranium equities
upward over the past couple of months.
TER:
You're forecasting spot uranium prices averaging $42/lb in 2014, but
three months into the year, the price is still struggling to break $36.
What will drive it over $42? When do you expect that to happen?
DS:
We think the move this year is likely to happen toward the end of this
year, as Japanese restarts spark a return of normal buying levels by
utilities. The uranium price should really start moving in 2015.
TER: What indicators should investors look for in watching the uranium price trend?
"Uranium prices have to go higher to incentivize more supply to meet the looming supply gap."
DS: One of the best indicators is Uranium Participation Corp. (U:TSX).
Since the fund's inception, this stock has been a remarkably accurate
predictor of where the uranium spot price is headed. When Uranium
Participation's share price is above its net asset value (NAV), the
market is baking a higher uranium price into its valuation of the stock
because the NAV is calculated at current uranium prices. For even more
precision, you can divide the company's enterprise value by its uranium
holdings for a rough dollar/pound estimate on what the market is
ascribing. So right now, we calculate the fund is implying $40/lb, and
that's over $4 above the current spot price. This is by no means a
bulletproof measure, but absent a black swan event, history tells us
that this could be the destination for the price in the near future.
TER:
You have said you see $70/lb as the price that will incentivize new
mining. What should investors do while they're waiting for the price to
reach that level?
DS: Buy uranium equities. It's that simple. We think prices are going higher, so buy uranium stocks well ahead of the upswing.
TER: Do you have a target time that you expect the price to reach that level?
DS: We're looking for the price to reach $70/lb in 2016. We forecast prices flat forward at $70 from that year onward.
TER: Which mining companies are the best investment prospects in this environment? Which are the weaker ones?
DS:
They say a rising tide floats all boats. We think all the uranium
stocks are probably going higher, or at least the vast majority of them.
But we also believe being selective will provide the greatest rewards.
Most investors should be looking at names with quality assets,
management teams and capital structures.
Among producers, our
preferred companies are focused on relatively high-grade projects with
solid balance sheets and fixed-price contracts that can buffer them
against near-term spot price weakness. After all, we think the spot
price could remain weak for most of the balance of 2014.
On the
explorer and developer side, the theme is the same—companies with cash
and meaningful upcoming catalysts and, again, in good jurisdictions. But
if you can tolerate an increased level of risk, I'd be looking at
companies with lower-grade assets in Africa. Those are probably the
highest-leveraged names out there.
TER: What other favorites can you suggest?
DS: Our top picks at the moment in the space are Fission Uranium Corp. (FCU:TSX.V) and Denison Mines Corp. (DML:TSX; DNN:NYSE.MKT).
Fission
has been a top pick in the space for some time. We have a $2/share
target and a Strong Buy rating. We view Patterson Lake South as the
world's last known, high-grade, open-pittable uranium asset. It has
immense scarcity value. There are not very many projects in the world
that can yield a drill intersection of 117 meters (117m) grading 8.5%
uranium, as hole 129 did in February. There is only one project in the
world where you would find an interval like that starting at 56m below
surface, and that's Fission's Patterson Lake South. It's in the best
jurisdiction, has a management team that has executed very well and has
huge growth potential. We think that property probably hosts over 150
Mlb uranium. We would be very surprised if the company was not taken out
at some point in the next two years.
"The uranium price should really start moving in 2015."
Denison
is another story we like a lot. We have a $2/share target and
Outperform rating on the stock. Denison has the most dominant land
holding of all juniors in the world's most prolific uranium
jurisdiction, the Athabasca Basin in Canada, the same region as Fission
Uranium's Patterson Lake South. The company will run exploration
programs at 20 projects in Canada this year, including an $8 million
($8M) campaign at Wheeler River, the world's third-highest-grading
deposit, which continues to grow in size, and with a new understanding
of its high-grade potential uncovered last year.
Denison has a
stake in the McClean Lake mill, which is also one of its crown jewels.
It's the world's most advanced uranium processing facility, and it's
located a stone's throw from hundreds of millions of pounds of
high-grade Athabasca uranium deposits. It's a big part of the reason why
we think Denison will get bought out at some point, particularly given
that to permit and construct a new mill in the basin would be a
herculean task. Denison has a very strong management team and cash
position and, once again, big-time scarcity value. It's one of the only
three North American uranium vehicles exceeding a $0.5B market cap.
Denison has been and will continue to be a go-to name in the space.
TER: What is another interesting name in your coverage universe?
DS: UEX Corp. (UEX:TSX)
owns 49% of the world's second-largest undeveloped, high-grade uranium
asset in Shea Creek and 96 Mlb in NI-43-101-compliant resources. It's
the biggest deposit with that kind of junior ownership in the Athabasca
Basin. It's a strategic asset and the company's main value driver. But
with the uranium price where it is, the company is also focusing on
shallower assets near what is now the southern boundary of the Athabasca
Basin, closer to Fission's Patterson Lake South. We're really
interested to see what comes of the Laurie and Mirror projects this
year.
We have a $0.60 target price on shares of UEX.
TER: Is any of that influenced by the fact that it has a new CEO?
DS:
The target price is not heavily influenced by the recent change in CEO.
I think the outgoing CEO, Graham Thody, did an excellent job. I'm very
hopeful that Roger Lemaitre will continue that trend. Under the new CEO,
I would anticipate that the company may ramp back up the level of work
intensity at Shea Creek, to build on the achievements of AREVA and the
UEX team as well as Thody. But given Lemaitre 's background, including
his experience as head of Cameco's global exploration, I wouldn't be
surprised to see UEX extend its view beyond the Athabasca Basin as a
potential consolidator in some other jurisdictions that may be lagging
behind a bit on valuation.
TER: You raised your target for Cameco from $25/share to $26/share. Are you expecting the rise to continue there?
DS:
Despite the recent run-up in shares, we think there's a good chance of
further strength. Cameco is the industry's blue-chip stock. It's the one
everyone thinks of when they think of uranium. Given its size and
liquidity, it is the only stock many of the big institutional fund
managers can invest in. With that backdrop, we think it's going to be
the first stock for fund flows as the space continues to rerate,
especially as we get more confirmatory news about Japanese restarts and
as Cigar Lake passes through the riskiest part of its ramp-up. We think
it should be a very good 24 months for the company.
TER: What other companies do you like in the uranium space?
DS: We recently upgraded Kivalliq Energy Corp. (KIV:TSX.V)
to an Outperform rating. Our target price there is $0.50/share. The
company has been a laggard in the last few months, but it has Angilak, a
solid asset in Nunavut with established high-grade pounds and huge
growth potential. Current resources stand at 43 Mlb, but we think there
is well over 100 Mlb of district-scale potential. The company is
derisking the asset by moving forward with engineering work, like
metallurgy and beneficiation, ahead of a preliminary economic assessment
potentially later this year. We're also excited to see what comes with
the newly acquired Genesis claims that sit on the same structural
corridor that hosts all the mines of the East Athabasca Basin.
We also like Ur-Energy Inc. (URE:TSX; URG:NYSE.MKT),
on which we have an Outperform rating and $2.20/share target price.
This stock has been on a major tear. We continue to expect great things
from Lost Creek in Wyoming. Early numbers from the mine, which just
started up in August, have been hugely impressive to us, a testament to
the ore body and execution by management. And the financial results
should be equally strong, given the company's high fixed-price
contracts. In all, it's a solid, low-cost miner in a safe jurisdiction,
which we think should be in a good position to grow production
organically or, using cash flow, buy up cheap assets in the western
U.S., a region ripe for consolidation of in-situ leach uranium assets.
TER: Do you have any parting words for investors in the uranium space?
DS:
I would just say we think the uranium price is going higher over the
next 12–24 months. So in anticipation of that upswing, we recommend
investors take a hard look at high-quality uranium stocks today.
TER: You've given us a lot to chew on. I appreciate your time.
DS: It's my pleasure, as always.
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DISCLOSURE:
1) Tom Armistead conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Fission Uranium Corp. and UEX Corp. Streetwise Reports does not accept stock in exchange for its services.
3) David Sadowski: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview. This interview took place on February 28, 2014. All ratings, facts and figures are reflective of the date of the interview.
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( Companies Mentioned: AREVA:EPA, CCO:TSX; CCJ:NYSE,
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