Description

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

November.

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

 

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

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.

 

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.

 

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

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

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

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.

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.