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
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