February 28, 2017 - 10:01pm EST by
2017 2018
Price: 11.09 EPS 0.19 0
Shares Out. (in M): 396 P/E 59.6 0
Market Cap (in $M): 4,389 P/FCF 33.0 0
Net Debt (in $M): 882 EBIT 242 0
TEV ($): 5,271 TEV/EBIT 21.8 0
Borrow Cost: Available 0-15% cost

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I wrote this up for my admission to Value Investor Club, but have since uncovered significant additional info to substantiate my thesis.
Cameco's share price has rallied by 40% off the lows of C$9.95 established in early
We view this bounce as a valuable opportunity to short the stock, given the precarious
outlook for the company. The traditional valuation metrics (above) look very stretched, while our rudimentary SOTP valuation points to a negligible value per share at the current uranium price. The de facto option value ascribed to the stock appears out of all proportion to the weak fundamentals and the likely need to place paper if the tax cases with the CRA and IRS go against the company.
The uranium industry is one of the most forecastable industries, due to the long lead times in permitting and building nuclear power stations and uranium mines. (typically >8 years). The industry runs an excellent PR campaign, making it surprisingly hard to ascertain the simple numbers that we present below.
These show that nuclear power generation peaked in 2006 and that for every new reactor being built, almost one reactor is scheduled to shut down over the next 10 years. From a short seller's perspective, any possible shift in the market will therefore be well sign posted months or years in advance.
The narrative that China and India etc. are the saviours of nuclear, is numerically inaccurate. In the 10 years from 2005 to 2015, the Non-OECD countries grew their power generated from Nuclear by only 183TWh p.a., compared to their growth of 331TWh for Wind and Solar and 934TWh for Hydro. In other words they voted with their feet for renewables in preference to nuclear, even when renewables were still much less competitive than today. Nuclear in the Non-OECD also constituted only 4.5% of electricity generated in 2015 vs. 18.3% in the OECD (2015). In the next 10 years all the new reactors currently under construction in the world will only add a combined 71,000MW of new capacity vs. the 58,000MW of currently known shutdowns. Given the age of >30 years of the OECD nuclear fleet, it's a given that a significant number of additional plants will become uneconomical to maintain during this coming decade. 
Generally, the reactors shutting down are in the OECD countries and are actual or potential clients of Cameco, whereas the new reactors are in the non-OECD countries and are often built or owned by state-owned corporations who mostly have their own closed-loop fuel supplies as part of the deal. (Nespresso model).
These shifts are far from benign for Cameco and other independent uranium miners and fuel service providers.
The de facto bankruptcy of Westinghouse (Toshiba) and Areva, who between them built more than half of all nuclear power stations in the world, are therefore not coincidental but symptomatic.
Cameco has long been viewed as the blue chip among pure-play uranium miners.
This reputation was previously well deserved, based on its high grade mines,
ostensibly prudent management and continued dividend payments all through the lean
years of the late 1990's and early 2000's up to the present day.
As I detail below, several key drivers of the group's business model are now either
broken or under structural threat.
The current stock price of C$14.70 equates to a trailing pe of 41 times, making the
shares vulnerable to a resumption of their downtrend.
The Spot price of Uranium dropped to US$18.00/lb (U3O8) in November from its
peak of US$137/lb in June 2007. The Contract price likewise dropped to US$30/lb in
December vs. US$95/lb in June 2007. Cameco is temporarily insulated from this
dramatic erosion in the market, thanks to its very large book of long-term sales
contracts entered into in more prosperous times. At end 2015, the group had 190m lbs
of U3O8 under contract until 2025. This was split as to 135m lbs for the 5 years from
2016 - 2020 and 55m lbs for the following 5 years. Because the group has a policy of
structuring these contracts on a blended basis consisting of 60% of the volume linked
to spot prices ruling at date of delivery and 40% at a pre-determined fixed price, it
boils down to an actual forward book of 40% x 190m lbs = 76m lbs sold at a fixed
forward price.
Cameco's disclosure on this forward book is fairly opaque, but using their illustrative
tables we derive an implied forward price of US$60/lb for the 40% of their contracts
that are fixed. In other words, the remaining forward book at end December 2016
amounted to 50m lbs and has an embedded value of US$1.7bn at the end December value of
US$26/lb (current spot price = $24.50/lb).
The sharp drop in the quantum of the forward book from 76m lbs (2015) to
50m lbs (2016) is only partially explained by normal sales during 2016 of 12m lbs at
fixed prices (18mlbs spot +12m lbs fixed). This suggests that the 2 settlements
Cameco entered into with restive clients during Q3 2016 involved no less than 12m -
14m fixed price lbs. for which it received a settlement of only C$59m (US$44m), vs.
a possible embedded value of US$576m.
Since year-end, Cameco announced that Tokyo Electric Power (Tepco), served notice of Force Majeure on its forward purchase from Cameco of 9.3m lbs at an eye-watering average price of US$108/lb. Using the December closing spot price of $26/lb, the dispute is worth US$758.2m or almost half Cameco's entire Forward Book. While Cameco believes that it will be vindicated in the expected arbitration of +- 2 years, the matter seems far from cut and dried.
The Tepco dispute illustrates a key vulnerability in Cameco's business model. Uranium is not an exchange cleared commodity, so contracts are principal to principal, with none of the usual marked-to-market margin requirements that helps to regulate normal futures. We estimate Cameco's Cash Cost of production at its 2 Canadian mines at US$32.58/lb, meaning that without the buffer of the Forward Book, it would be incurring cash losses of US$8/lb (US$216m p.a.) at current spot prices. The current approach to weather the storm by running down the embedded value in the Forward Book, can therefore come unstuck if other clients opportunistically following Tepco's example.
As a Uranium miner, Cameco has seen its competitive advantage on the cost curve
substantially eroded by Kazakhstan.
Kazakhstan's production has grown from 9m lbs in 2004 to 61m lbs last year, in a
market that has seen mined Uranium grow from 104m lbs in 2004 to 146m lbs
last year. In other words, Kazakhstan has gone from 9% to 42% of the market in just
over 10 years. What is more concerning from a Cameco perspective is that
Kazakhstan's production costs position it at the bottom end of the cost curve.
Uranium One (Rosatom), which owns around 25% of Kazakhstan's output on an attributable basis,
disclosed average total cash costs of only US$7/lb for Q3 2016. This drop from
US$10/lb a year earlier was helped in large part by the sharp depreciation of the
Kazakh currency the Tenge. Kazakhstan may have mined its best orebodies first, but
it has a further 40 years of minable reserves at the current run rate.
The announcement by Kazakhstan in January that it will curtail production by 10% might hold for a while, but Cameco's Inkai mine in Kazakhstan (40% Cameco, 60% Kazatomprom), plans to double production from 5.2m lbs to 10.4m lbs over the next 3 years, once the regulator approves the expansion into Block 3.
As mentioned, Cameco's cash costs exceed US$30/lb. The barriers to exit on the North American assets can be deduced from the C$60m of capex still going into the 2 mothballed operations, viz. Rabbit Lake and the ISR mines in the US this year.
Other notable players on the cost curve are the enrichment plants. As the enrichment
industry discarded the last gaseous diffusion plants (GDP's) in favour of using
centrifuges, the cash cost of enrichment has dropped dramatically. Today's centrifuges
consume less than 3% of the electricity used to perform a Separative Work Unit
(SWU) in a GDP and are 1400 times thriftier than the calutrons used in the Manhattan
Project. This has seen a constant decline in the price of SWU's from over $190/SWU
to recent lows around $50. At these prices, enrichment plants can "make" Uranium at
roughly $5/lb by simply underfeeding their processes by blending in previously
discarded tails.
With China and other countries committing to Nuclear in a big way prior to
Fukushima, they geared up massively on enrichment capacity from a strategic
perspective. With minimal long-term contracts being entered into in both 2015 and
2016 and low spot market activity, the enrichment plants that were already surplus to
market demand are now seriously under-utilised and have only one logical route to
recoup overheads. "Make" more Uranium. This material is then sold rather
indiscriminately into an already thin market, enforcing the vicious circle.
While Cameco management are fond of repeating the narrative that the market is
consuming 100m lbs more than it is contracting and hence storing up trouble for the
future, the truth might be somewhat different. The authoritative UX Consulting
released a report in late 2015 in which they averred that among the various players in
the Uranium market, there might be more than 1.1bn lbs of U3O8 equivalent of
inventories extant. Even more worrying, UxC believed that a significant chunk of this
material has already been enriched or even fabricated in market ready fuel assemblies.
Even if UxC are only broadly right, then these stock levels equal more than 6 years of
current demand leaving the Uranium market comfortably the most overstocked
commodity market since the collapse of the International Tin Council Buffer Stock in
1985. By comparison, stock levels in the Copper market seldom exceed 30 days’
consumption. The Buffer Stock operated from 1953 to 1985 and eventually held
roughly 15 months of global demand (including the ITCBS derivatives exposures). It
took the Tin market until 2007 to regain the nominal levels of 1985.
Added to this price inelastic first quartile supply is material being sold by the US
military, normal reprocessing of spent fuel and the Uranium being produced as a by-
product, or by state-owned entities.
BHP’s Olympic Dam mine in Australia is a Copper, Uranium, Gold and Silver mine,
whose principal profits are derived from Copper. BHP is moving ahead with plans to
potentially double Olympic Dam’s Copper output to 450,000t p.a. by the mid 2020’s.
With Uranium production growing in lock step, this will see the mine producing 10m
lbs next year and potentially up to 22m lbs p.a. in the mid 2020’s vs. only 8m lbs last
year. With the mine’s Copper costs postulated in the first quartile of the cost curve,
the Uranium is clearly going to be produced regardless of price. The Resource hosts a
remaining 5.6 bn lbs of contained Uranium.
A further significant concern for Cameco, must be the new Husab mine in Namibia
(previously called Rossing South). This mine is expected to reach its nameplate
capacity of 15m lbs in 2017, or almost 10% of global demand. The owners, China
General Nuclear Power Holdings, paid $2.2bn to acquire the mine from Extract
Resources and a further $2.1bn to build the mine. They are unlikely to curtail
production at this shallow open pit mine due to short-term weakness in the Uranium
price. In fact it appears as though China is vertically integrating from mine to power
plant and that the entire demand that everybody pencilled in for China in their own
business models, will instead be satisfied by Chinese owned assets - be it yellowcake
or enrichment requirements.
Further, mines like Rio Tinto’s Rossing in Namibia or Ranger in Australia may be
high cost, but they still have meaningful long-term contracts against which to deliver
at break-even or better. Likewise for Areva’s Somair mine in Niger. These are large
corporates with long time horizons and triple bottom lines to consider. As Cameco
itself stated in a recent conference call, it costs significant money to mothball a mine
like Rabbit Lake, not to mention shutting it for good, i.e. real barriers to exit. It’s
therefore somewhat disingenuous of Cameco’s CEO, Tim Gitzel, to say that they have
been “surprised by how sticky the supply has been”.
The tax dispute with the Canadian Revenue Authority (CRA) and IRS in America has its roots in the premium price of long-term off-take commitments vs. the generally lower Spot price. The Nuclear industry has always attached a premium to supply certainty. This started
when the US and British Nuclear authorities offered soft loans and premium prices to
the South African gold mines to incentivise them to produce Uranium after WWII (78 shillings a pound ~$80/lb today).
In recent times, the premium has often reached 50% or more. (Currently US$32.50/lb for Contract vs.
US$24.50/lb. for Spot).
While the detail is not disclosed, it appears that Cameco formed a wholly-owned
Swiss entity, Cameco Europe Limited some 15 years ago, to which the Canadian
mines sell at Spot. This entity then sells to Cameco’s long-standing customers on
Contract, reaping an almost permanent and risk-free premium. The current extreme
weakness in the spot price not only threatens this neat little earner, it risks toppling
Cameco’s entire tax case with the CRA. The point is that the mines and offices in
Canada incurred a loss of C$464m in 2016, while the “Foreign”
subsidiaries (CEL and Nukem) earned C$310m in profits. The more the spot price
drops, the greater this farce becomes, not to mention the cost of paying Swiss and
German taxes on the notional foreign profits, while the group as a whole incurs losses at a pre-tax level.
Of further concern is that management suggested in a recent conference call that the
buyers’ strike of the past 3 years amounting to some 300m lbs of “under-contracting”,
might in fact be a strategy by Nuclear customers to “normalise” the unusually large
contango in the Uranium market. Given the hard times in the Nuclear power market,
this might not even be so much a strategy, as a result of banks reining in lines of
credit to an industry that is non-standard and perceived as risky under Basle III risk
weightings. The diamond cutting centres (especially in Antwerp) went through a
painful adjustment for these reasons over the past 5 years with decades old credit
facilities being cancelled.
Whatever the truth, the stock levels appear far out of line with normal requirements
and all those players long of Uranium in the past few years are nursing very serious
losses. Not least Cameco itself, which has seen its stock of 28 - 31m lbs of carry-over
Uranium drop by some C$650m in the past 12 months alone. It would be profoundly
ironic if at any time going forward, Cameco should become a forced seller of its own
inventory of Uranium in a weak market, thereby exacerbating
its woes. It’s also unclear to what extent Nukem’s significant trading book has
been impacted by market movements and whether they may or may not have residual OTC derivatives positions.
The broader outlook for Nuclear power looks very weak, with smaller Nuclear plants
in the US operating at $44/MWh according to the Nuclear Institute. This is now
frequently below actual Wholesale Power Prices received, caused by the fact that
Renewables have “right of way”. This and the median age of 30+ years has seen 5
closures announced in the past 3 years, completely balancing out the 5 new plants
being built. The forecasts of a growing Nuclear industry somehow always assumed
that the existing fleet would continue operating for ever thanks to uprates and permit
extensions from 40 to 60 and even to 80 years.
The recent problems at San Onofre in California and at a number of French nuclear
plants tell a more sobering story. With the tender awarded at $4.4bn to close and
rehabilitate San Onofre, the full cost of the life cycle of a Nuclear power plant is moving
from the realms of theoretical calculations to current numbers. The cost seems to
approximate $2m/MW of generating capacity (roughly the cost of building a new gas
plant in its entirety).The cost also excludes the cost of spent fuel disposal In an era of IFRS accounting standards this can lead to significant upward revisions in
the closure liabilities of power companies.
In the same vein, should the Trump administration revive Yucca Mountain as a
repository for spent fuel, it will likely see the re-imposition of the Fuel Storage Levy
per MW of Nuclear Power generated, with negative cash flow impacts for the
industry. While being “a good thing”, it might nonetheless hasten the closure of
further smaller nuclear plants.
The United States generated 32.6% of the global output of nuclear power in 2015 so going forwards, it will play a major role in shaping the future of the traded uranium market. In our view nuclear can only regain its previous viability in America if electricity demand starts growing again, or a carbon tax is introduced, or renewables lose their subsidies and right of way, or capacity auctions and congestion levies are structured to specifically favor nuclear. These scenarios are possible but not probable.
In summary, I don’t believe that Cameco can continue paying C$160m of dividends
while running at barely better than break-even, incurring accounting losses of
C$400m in its Canadian subsidiaries, having an unsustainable net debt to Ebitda ratio
and facing the real likelihood of a C$2.2bn adverse ruling on their CRA court case.
On a sum of the parts basis, the group is potentially worth as little as C$1bn or less, due to
the barriers to exit in its marginal mines and nuclear processing facilities. As the
group’s shares are restricted in terms of foreign ownership and voting rights, Cameco
does not have the same ability to raise capital, dispose of assets or enter into corporate
transactions as would otherwise be the case. I therefore see a strong likelihood of a
further derating to C$2.50, especially when the dividend is inevitably passed, the tax
case goes against them and the group seeks to shore up its balance sheet.


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.


First Catalyst : Expect the 4x quarterly dividend of 10c (C$160m p.a.) to be
cancelled in 2017.
Second Catalyst : While well documented, Cameco risks an adverse judgment of up to
C$2.2bn in its 8 year long dispute with the Canadian and US Revenue Authorities. Judgement
is expected in the 2nd half of 2017. The amount due in cash might be between
C$1.5bn and C$1.7bn, with some of the balance lodged in cash but mostly only by way of letters
of credit with the CRA.
Third Catalyst : The full implications of the withdrawal by Westinghouse (Toshiba) from the nuclear construction industry, will only become apparent in the next few years. It might have a lasting impact on the ability to finance new nuclear plants globally, with the UK and India's new-builds the first to be impacted directly.
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