When it comes to uranium market sentiment, "it's all about Japan," says David Talbot, senior mining analyst at Dundee Capital Markets. With restart applications trickling in and reactor construction underway throughout the world, a turnaround looks less like an "if" and more like a "when." In the meantime, Talbot sees many investors sitting on the sidelines. In this interview with The Energy Report, Talbot discusses the catalysts that could trigger the next uranium boom and the companies that could make investors wish they had arrived at the party a little earlier.
The Energy Report: In your last interview with The Energy Report in December, you were expecting that 2013 would be the turnaround year for uranium. What's your assessment of where things stand now?
David Talbot: Our long-term outlook remains essentially the same as last year. What we and most of the industry underestimated was the possible impact of cash-strapped sellers on the spot market. Despite recent spot market weakness, uranium producer equities have pushed ahead 10%, developers 12% and explorers 17%, on average. A uranium supply crisis is still brewing and the fundamentals do remain strong. Demand is stable and reasonably predictable. The weak spot price still threatens future mine supply with more closures, cancellations and deferrals of mining projects. The all-important catalyst at the end of this year is the end of the Russia-U.S. HEU "Megatons to Megawatts" program, which in our view will not be renewed. That means 24 million pounds (24 Mlb) of secondary supply comes offline with no replacement − equivalent to the entire production of Cameco Corp. (CCO:TSX; CCJ:NYSE). Uranium prices are too low to incentivize new builds right now. We think prices must rise, as will the equities. The Uranium One Inc. (UUU:TSX)takeout deal approved in March indicates Russia wanted to lock down a reliable uranium source. Guangdong's (CGNPC) purchase of Extract Resources Ltd. is the preeminent takeover after Uranium One. As these utilities purchase these big projects it leaves less supply on the table for the rest of the utilities.
TER: The big price drop in early July sent uranium down to a seven-year low. What happened there? Was this the bottom or is there more to come?
DT: Uranium prices have dropped significantly in the past month or so. A few weeks ago, near-term requirements appeared low and the first applications for Japanese reactor restarts were not yet filed. Restrictions were also removed from the U.S. Department of Energy regarding how much uranium it's allowed to sell in any given year. That added to the already negative sentiment.
The following week, a few suppliers failed to sell to a certain utility and were forced to place that material on the market relatively cheaply. That led to the spot price retreating even more. More positive news coming out of Japan on restarts should help the price edge back up. But during the summer lull, negative sentiment could still dominate, and prices could drop further.
TER: What catalysts might cause a significant uptrend in prices going to this predicted $70+ per pound ($70+/lb) level?
DT: It's all about Japan. Japanese restarts should provide a psychological boost. Fukushima really ended the last uranium bull run and reactor restarts will likely get that going once again. Once Japan moves forward, the rest of the world will start to catch up on the uranium purchases they've been deferring.
Investors are likely to return at that point. Utilities will also have to return to term contracting as they do have significant unmet uranium requirements over the next four or five years. There are more reactors planned or proposed now than ever before, and we are seeing contract awards for construction of reactors, like in Turkey for example, and the UK reaffirmed its commitment to nuclear only a few months ago. We continue to forecast a supply/demand deficit by the end of 2014. By 2020, we expect about 240 Mlb of demand to be offset by only ~200 Mlb of total supply, including secondary supplies.
TER: The U.S. imports about 90% of its uranium, yet we still have significant recoverable deposits. What do things look like for domestic production?
DT: Things are moving forward on the permitting front in the U.S., which remains the largest uranium consumer in the world with the largest reactor fleet. It produced only about 4.1 Mlb last year, which was about a 4% increase from the prior year. We'd expect that number to increase to perhaps 4.5–5 Mlb this year. Cameco is by far the largest producer in the country and plans to increase production at both its Smith Ranch-Highland plant in Wyoming and its Crow Butte plant in Nebraska. We expect combined production to improve from 1.9 Mlb last year to about 2.6 Mlb this year. That should offset some production losses from, say, Uranium One, which decided not to develop any more well fields at its Willow Creek in-situ recovery (ISR) project in Wyoming.
We're also expecting increased production from Uranium Energy Corp. (UEC:NYSE.MKT) from its Palangana operation in south Texas. We're expecting initial production out of Ur-Energy Inc.'s (URE:TSX; URG:NYSE.MKT) Lost Creek mine in Wyoming. The U.S. still imports about 90% of its 55 Mlb per year consumption. Producers such as Ur-Energy and Uranerz Energy Corp. (URZ:TSX; URZ:NYSE.MKT) have had some preferential contracts in the past. For example, we believe that Ur-Energy's contracts with utilities are in the $60/lb or greater range. That's a pretty good premium to existing spot prices. Energy Fuels Inc. (EFR:TSX; EFRFF:OTCQX) sold its uranium last quarter for an average price of $56.23/lb when the average spot price for the period was in the low $40s.
TER: Energy Fuels is the largest U.S. conventional uranium producer, yet its market cap is only $130 million ($130M). What's going on there?
DT: Energy Fuels has huge leverage to uranium prices and is one of our top picks in a rising uranium price environment. It has high price contracts, an effective and acquisitive management team and huge expansion potential. The company has really been focused on running only its lower-cost operations while delivering about 100% of its production into these higher-priced term contracts.
This stock is still relatively unknown, but these guys have the potential to go from around 1 Mlb this year to 3–5 Mlb going forward. It recently announced an acquisition of Strathmore Minerals Corp. (STM:TSX; STHJF:OTCQX) in an all-share deal worth about $30M. Shareholders could benefit with a stronger company, lower-cost project pipeline and relationships with a couple of Asian utilities with deep pockets, KEPCO and Sumitomo. Strathmore's flagship Roca Honda project in New Mexico has some synergies that can really work with Energy Fuels. The acquisition eliminates Strathmore's need to build a mill, potentially making the Roca Honda project much more economic. We definitely see Energy Fuels as an up-and-comer in a rising uranium price environment.
TER: So where is it trading now and what's your target price?
DT: The stock right now is trading at $0.18 and our target price is a cool $0.75.
TER: You've been out on some site visits. Tell us a little about what you've seen.
DT: I enjoy site visits and have been to about 80 different uranium projects around the world. I went back to Wyoming in July and saw three ISR mines, Ur-Energy's Lost Creek, Uranerz's Nichols Ranch and Cameco's Smith Highland Ranch operations. Ur-Energy is the best performer this year out of the developers. It's up 70% over the past few months. We were very impressed with the innovative design of the Lost Creek plant and feel very comfortable with the expertise, depth and competence of the company's team.
The Nuclear Regulatory Commission pre-operation inspections are underway at Lost Creek and we expect production by August with first deliveries in October. We're looking for about 200,000 pounds (200 Klb) of production this year. Maybe 800–900 Klb next year with production costs under $25/lb. The Pathfinder acquisition brings two high-quality assets, primarily the Shirley Basin, which is the next project to be developed. There's a little bit of financing risk remaining, but we expect that to be largely sorted out. We maintain our buy on Ur-Energy and target price of $2.30 per share from the current $1.29 level.
TER: How about Uranerz?
DT: Uranerz runs a bit different model, permitting smaller deposits and only constructing the frontend of the plant. It plans to toll process its resin at Cameco's Smith Ranch facility where Cameco will take that loaded resin, precipitate the uranium, dry and package it. This arrangement benefits Uranerz by minimizing start up risks and saving capital through deferred completion of its own mill, and may even save on operating costs. Uranerz just started construction of two deep disposal wells at about $3M each; it will need these wells before production can start. We expect about 500 Klb of production next year with total cash costs of around $37/lb—somewhat higher than Ur-Energy's costs due to higher taxes and royalties in Wyoming. Uranerz is now trading at $1.35 and we maintain a buy rating and a $2.65 target price.
We also visited Cameco's Smith Highland Ranch ISR operation, which has been in production for over 16 years. Cameco's U.S.-based operations have been core long life, low-cost projects for years. About 12% of Cameco's production comes from the U.S., accounting for half of total U.S. production. About 18% of our NAV comes from its U.S. operations. We're expecting increased production this year out of North Butte and see Cameco moving forward with the 15 Mlb Reynolds project, which is likely going to be permitted around yearend. We've got a buy on Cameco and target price of $25.20.
TER: Why did you only start covering Cameco now?
DT: With well over 20 analysts covering Cameco, I felt my value was better added covering earlier-stage development and exploration stories. I initiated coverage on Cameco in June as a clear defensive play in today's uncertain uranium environment. It's an industry leader with world-class assets. Cameco rarely misses its guidance and looks poised to continue the strong track record despite low uranium prices. The big catalyst this year is the commissioning of the Cigar Lake project, expected any day now. We're forecasting 23.4 Mlb of production this year, 25.4 next year and just under 36 Mlb by 2018. Cameco is where the big money is going in the sector.
Despite our belief that producers are where investors should be going right now, we do want to highlight two exploration companies, Fission Uranium Corp. (FCU:TSX.V) and Denison Mines Corp. (DML:TSX; DNN:NYSE.MKT). Both are exploring some exciting high-grade projects in the Athabasca Basin. Very few companies in the sector are receiving as much attention as these two names. We have Fission Uranium as a buy, speculative risk, no target. Fission owns 50% of the highly perspective and the much-talked-about PLS discovery in the Athabasca Basin. This has propelled the stock and also reignited interest in the whole sector. PLS is high grade, shallow, consistent and thick. The team's already discovered three zones here, with indications that more discoveries are likely. There are already about 30 Mlb discovered in these three zones with 75 Mlb or more possible. Fission's very first hole this summer intersected mineralization over 85 meters (85m). Perhaps the market has priced in the uranium that's already been found, but we don't think it accounts for the vast upside potential.
Fission has a very skilled technical team that already succeeded in discovering the J Zone and selling it to Denison. This team discovered the original Boulder Field on PLS with its patent pending airborne radiometric survey technology, and now it's further expanding the PLS discovery. Fission's entrepreneurial management team has significant ownership and is definitely aligned with shareholder interests. This is an exciting story that's only going to improve with the 44-drillhole program currently underway.
Denison Mines is another investor favorite that trades very well. We rate Denison as a buy with a $2.00 target price. The company has majority ownership in the world's third-highest-grade deposit, Phoenix, that already has 60 Mlb of uranium at 16.6% U308. We easily see 20–30 Mlb upside from here. The latest drill hole announced about two weeks back turned out to be the best hole ever on the property, 43% over 10m. A significant part of our NAV for Denison comes from a strategic value of its 22.5% ownership in the McClean Lake Mill. Its world-class mill is one of just three mills in the Athabasca Basin, and the only one capable of processing ultra high-grade ores. It represents near-term cash flow potential. Denison holds another large deposit called Midwest and a plethora of other exploration projects. This company is an attractive entry point for investors who want exposure to the basin. Between the takeover potential and the ultra high-grade Phoenix deposit, we clearly see investors supporting its premium valuation relative to its peer
TER: Any others you'd like to mention?
DT: We like Paladin Energy Ltd. (PDN:TSX; PDN:ASX) and rate it as a buy with a $2.40 target price. Paladin has really delivered this year. Production and sales targets were met with realized prices 13% above spot. Cost-cutting targets at both operations exceeded expectations. Operations achieved capacity. Debt was trimmed. Production guidance was increased for next year and we believe a potential game-changing strategic initiative lies waiting in the wings. Paladin has huge leverage to rising uranium prices with costs that are coming down rapidly. We do expect a strategic partnership to be announced likely later this quarter. We believe that Paladin might be willing to sell about 20% of its Langer Heinrich mine in Namibia. Our NAV valuation suggests perhaps a $200–300M price tag for that. The company has a disciplined expansion approach here. We think right now is the time for investors to take advantage of the turnaround in Paladin. The stock still trades at a discount to its peers. With this strategic alliance, we do expect a rerating in the stock as debt levels fall further.
Finally, we like Uranium Participation Corp. (U:TSX) as a buy, high risk, with a $7.50 target price. Uranium Participation is essentially a uranium ETF holding 13.4 Mlb of physical uranium and therefore its easy to calculate an NAV for the stock. We estimate its NAV right now at $4.81 per share at $34.50/lb uranium. We view Uranium Participation as a proxy for sentiment from the sector and a low-risk investment vehicle for those who seek pure uranium price exposure with no operational permitting or geopolitical risk. We suggest getting in this name before uranium prices rally further.
TER: So what does the future look like for uranium and what should investors be doing to hopefully benefit and make some money here?
DT: Once we get through the summer doldrums and get some visibility on the Japanese nuclear power restarts, we expect uranium prices to firm and rise toward the end of this year and into next year. We are still calling for $65/lb uranium in the long term. To get to those levels, investors will need to see higher prices as incentives before any large uranium mines are built. Based on history, there's a chance that once uranium prices do start to rebound, stock prices could jump quickly. It's our expectation that many investors will sit on the sidelines, skip some of these early gains and likely come into the sector once it's clear what direction it's headed in. In the meantime, we suggest that investors look to the producers, especially those companies that are larger and more liquid. They should also look at select exploration companies, such as Fission Uranium or Denison Mines. All eyes are on those companies right now and their exploration programs are in full swing and expected to deliver significant news flow throughout the summer.
TER: Thanks for your thoughts today, David.
DT: Thank you for having me.
Dundee Capital Markets Senior Mining Analyst David Talbot worked for nine years as a geologist in the gold exploration industry in Northern Ontario. David 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. David is a member of the PDAC, the Society of Economic Geologists and graduated with distinction from the University of Western Ontario, with an Honors Bachelor of Science degree in geology.