Uranium

[Tommy]

$URG - UR-Energy: A World-Class Junior Uranium Producer Right Here In The USA With Huge Potential

http://seekingalpha.com/article/1797652-ur-energy-a-world-class-junior-uranium-producer-right-here-in-the-usa-with-huge-potential?source=email_rt_article_readmore

Editor's notes: Recent macro factors have masked the positive developments in UR-Energy's operations. Value Investor Dennis Beaudet sees those headwinds subsiding, resulting in a potential double.
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Disclosure: I am long URG. (More...)

Finding value is getting harder and harder as the equity indexes reach new highs. Most sectors are definitely overbought. However, there are those sectors in the beat up commodity based equity world that are certainly not near the overbought zone and have been really beaten up for some time now. One of these is the Uranium mining sector.

Some background on the sector

The following 3-year chart of the URA ETF (which is a relatively good representation of the global uranium mining sector) shows the ugliness of the uranium mining industry's share price performance over the last three years:

URA Chart

The downtrend in the sector began immediately after the Fukushima Daiichi nuclear plant meltdown in Japan in early 2011. The failure of this plant was as a result of a 55 foot Tsunami rather than a systemic failure of the plant itself. The massive waves knocked out the plant's redundant power supply thus disabling the plant's ability to shut down in a controlled manner. Well regardless of the cause of the failure, the result was a large area contamination which resulted in the displacement of ~150,000 people and a massive clean up and plant dismantling cost (which is still underway). This failure and its awful result caused the Japanese government to shut down all of its 52 reactors. Two of the reactors have since been restarted (but have since been shut down for maintenance) and the rest are undergoing rigid safety inspections and a number are also being upgraded. It is believed that at least half of the reactors will be put back into operation once safety concerns are satisfied and necessary upgrades are completed, but this process is taking much longer than originally thought.

Demand has been reduced as a result (for the short term)

Demand has been temporarily reduced as a result of the fall out of the Fukushima Daiichi incident. Japan represents about 10% of the world's nuclear reactor fuel demand, so with this many plants idled it reduces demand. The Japanese utilities, despite having their reactors idled, have honored their long-term supply contracts and have been taking and stockpiling more fuel. It is estimated that the country now has nearly five years' worth of reactor fuel in inventory. The fear in the market that is keeping the global utilities from stepping up their purchases is that the country may decide to not restart the rest of their reactors and dump this large supply of product on the market depressing prices even further and prolonging the downturn. This is highly unlikely however if the county wants to stay solvent as its utilities are currently importing LNG at absolutely horrendously high international regional prices and paying for it with a much devalued Yen because of the country's massive monetary currency printing program that is currently in place. Germany (an alternative energy leader) has also stated that they are going to be nuclear power free by 2020, which seems a little unrealistic at this point. Nonetheless, their intentions also add to the overall view of the sector.

However, supply is also being reduced

Mitigating this short to medium-term reduction in demand is reduced "surface" or "secondary" supply of U3O8 as a result of the ending of the HEU agreement with Russia (megatons to megawatts program) which as a result will be no longer supplying downgraded (from weapon grade to fuel grade) highly enriched uranium to the market to the tune of ~12% of the world supply.

Another factor that is beginning to hinder growth in supply is the current price of uranium fuel, with the spot price being at an eight-year low at ~$35.50 per pound and the long-term contract price ~$50.00. At these prices many mining development projects have been put on hold as for most mines the hurdle price required for an economic project is ~$70.00.

Demand will increase substantially in the medium term and the long-term future looks even brighter

The developing world sees Nuclear power as a must for electrical power generation and countries like China, Russia, India, South Korea and even some of the oil rich Arab countries have a very robust nuclear power plant development program underway. The United Arab Emirates (UAE) has plans for building nuclear reactors, which sends an important signal to the market. Even Saudi Arabia is building twenty!! As one of the most oil-rich countries in the world, it could probably power itself with oil, yet is looking to diversify into nuclear. I think that's a very strong signal of the importance of nuclear power generation to even a country that produces oil extremely inexpensively relative to the rest of the world.

The world nuclear association sees increases in capacity coming from four fronts:

Nuclear power capacity worldwide is increasing steadily, with nearly 70 reactors under construction in 13 countries.
Most reactors on order or planned are in the Asian region, though there are major plans for new units in the USA and Russia.
Significant further capacity is being created by plant upgrading.
Plant life extension programs are maintaining capacity, in USA particularly.

In total there are currently 435 operational nuclear plants in the world that provide nearly 14% of the world's electrical power. In addition to this there are currently almost 70 plants under construction as listed in the chart below and another 160 in development:

Commercial
Operation* REACTOR TYPE MWe (net)
2013 Iran, AEOI Bushehr 1* PWR 950
2013 India, NPCIL Kudankulam 1 PWR 950
2013 India, NPCIL Kudankulam 2 PWR 950
2013 China, CGNPC Hongyanhe 1* PWR 1080
2013 China, CGNPC Ningde 1* PWR 1080
2013 Korea, KHNP Shin Wolsong 2 PWR 1000
2013 Korea, KHNP Shin-Kori 3 PWR 1350
2013 Russia, Rosenergoatom Leningrad II-1 PWR 1070
2013 Argentina, CNEA Atucha 2 PHWR 692
2013 China, CGNPC Ningde 2 PWR 1080
2013 China, CGNPC Yangjiang 1 PWR 1080
2013 China, CGNPC Taishan 1 PWR 1700
2013 China, CNNC Fangjiashan 1 PWR 1080
2013 China, CNNC Fuqing 1 PWR 1080
2013 China, CGNPC Hongyanhe 2 PWR 1080

2014 Russia, Rosenergoatom Novovoronezh II-1 PWR 1070
2015 Russia, Rosenergoatom Rostov 3 PWR 1070
2014 Slovakia, SE Mochovce 3 PWR 440
2014 Slovakia, SE Mochovce 4 PWR 440
2014 Taiwan Power Lungmen 1 ABWR 1300
2014 China, CNNC Sanmen 1 PWR 1250
2014 China, CPI Haiyang 1 PWR 1250
2014 China, CGNPC Ningde 3 PWR 1080
2014 China, CGNPC Hongyanhe 3 PWR 1080
2014 China, CGNPC Yangjiang 2 PWR 1080
2014 China, CGNPC Taishan 2 PWR 1700
2014 China, CNNC Fangjiashan 2 PWR 1080
2014 China, CNNC Fuqing 2 PWR 1080
2014 Korea, KHNP Shin-Kori 4 PWR 1350
2014? Japan, Chugoku Shimane 3 ABWR 1375
2014 India, Bhavini Kalpakkam FBR 470
2014 Russia, Rosenergoatom Beloyarsk 4 FNR 750

2015 USA, TVA Watts Bar 2 PWR 1180
2015 Taiwan Power Lungmen 2 ABWR 1300
2015 China, CNNC Sanmen 2 PWR 1250
2015 China, CGNPC Hongyanhe 4 PWR 1080
2015 China, CGNPC Yangjiang 3 PWR 1080
2015 China, CGNPC Ningde 4 PWR 1080
2015 China, CGNPC Fangchenggang 1 PWR 1080
2015 China, CNNC Changjiang 1 PWR 650
2015 China, CNNC Changjiang 2 PWR 650
2015 China, CNNC Fuqing 3 PWR 1080
2015 India, NPCIL Kakrapar 3 PHWR 640
2015? Japan, EPDC/J Power Ohma 1 ABWR 1350

2016 Finland, TVO Olkilouto 3 PWR 1600
2016 France, EdF Flamanville 3 PWR 1600
2016 Russia, Rosenergoatom Novovoronezh II-2 PWR 1070
2016 Russia, Rosenergoatom Leningrad II-2 PWR 1200
2016 Russia, Rosenergoatom Vilyuchinsk PWR x 2 70
2016 India, NPCIL Kakrapar 4 PHWR 640
2016 India, NPCIL Rajasthan 7 PHWR 640
2016 Pakistan, PAEC Chashma 3 PWR 300
2016 China, China Huaneng Shidaowan HTR 200
2016 China, CPI Haiyang 2 PWR 1250
2016 China, CGNPC Yangjiang 4 PWR 1080
2016 China, CGNPC Hongyanhe 5 PWR 1080
2015 China, CNNC Hongshiding 1 PWR 1080
2015 China, CGNPC Fangchenggang 2 PWR 1080
2016 China, several others PWR

2017 USA, Southern Vogtle 3 PWR 1200
2017 Russia, Rosenergoatom Baltic 1 PWR 1200
2017 Russia, Rosenergoatom Rostov 4 PWR 1200
2017 Russia, Rosenergoatom Leningrad II-3 PWR 1200
2017 Ukraine, Energoatom Khmelnitsky 3 PWR 1000
2017 Korea, KHNP Shin-Ulchin 1 PWR 1350
2017 India, NPCIL Rajasthan 8 PHWR 640
2017 Romania, SNN Cernavoda 3 PHWR 655
2017? Japan, JAPC Tsuruga 3 APWR 1538
2017 Pakistan, PAEC Chashma 4 PWR 300
2017 USA, SCEG Summer 2 PWR 1200
2017 China, several

2018 Korea, KHNP Shin-Ulchin 2 PWR 1350

So though the current situation is terrible with respect to the commodity price being at an eight-year low, resulting in the equity of miners being pummeled, there is light on the horizon for the future from a macro perspective however time and patience is required.

There is a junior producer that is already bucking the sector trend

This company is UR-Energy (URG) a Colorado based junior uranium mining company that has done nothing short of a fantastic job on all fronts to become the first new producer of uranium fuel in the heart of the USA in more than 25 years. This is significant from a strategic perspective in that the US is a severe net importer of U3O8 producing supplying only ~10% of its nuclear fuel needs from mines on US soil. I am sure that the US government appreciates any new US domiciled producer from a strategic perspective as it contributes to increasing domestic supply of this important power generation fuel (which despite its shortcomings is one of the greenest ways to generate ample supplies of electrical fuel).

Some specific background and detail on the company

UR-Energy is a junior mining company focusing on exploration and development of uranium properties in the United States and in Canada. UR-Energy was incorporated in 2004 and trades on the Toronto Stock Exchange under the symbol (URE.TO) and on the NYSE under the symbol URG.

In the United States, the Company's current Wyoming properties contain NI 43-101 compliant resources of 20.55 million pounds of uranium in the measured and indicated category plus 4.67 million pounds in the inferred category. In Nebraska, the Company has leased approximately 35,000 acres (not contiguous) for initial exploration. The Company's land position, based upon an extensive in-house geologic study, was secured in areas which may contain geology similar in nature to Cameco Corporation's (CCJ) nearby Crow Butte deposit which is currently being mined by the in-situ recovery method. (click to enlarge)

In Canada, the Company's Screech Lake project is in the Thelon Basin. The Company acquired this project based upon the presence of key geological vectors and encouraging supporting data from 1970s-era exploration work. The property is located in the eastern part of the Northwest Territories. While the Athabasca Basin in Saskatchewan is better known and contains 65% of the known future capacity of global uranium production, the Thelon Basin is highly prospective for unconformity-type uranium deposits, the highest grade known uranium deposits.

The company's shares have been outperforming its peers

If we compare the company share price performance to the URA (an ETF of the global uranium mining industry) and with Cameco (the most investable uranium producer on earth) as we can see from the chart below, URE is up 18% in the last twelve months versus the URA ETF which is down 31% and Cameco which is flat (even with a nice spike yesterday because of a fantastic Q3). The major reason for this out performance is that the company's share price has been undergoing a re-rating as a result of transitioning from an explorer/developer to a producer in fine style and a number of significant catalysts have occurred in this regard.

URG Chart

The company has worked through a lot of adversity over the last 6 years. Going through the property development stages of having to apply for and receive numerous permits to obtain all of the approvals necessary to begin construction of its mining and processing facilities at its flagship Lost Creek property in Wyoming. Upon achieving the final BLM permit last October the company immediately commenced construction of their mining and processing facilities and they completed both facilities on time and on budget in July of this year and after a final inspection by the NRC they were given the go ahead to commence production which began this past August. The company is in the process of ramping up production and communicated recently that they are ahead of schedule and exceeding their and the market's expectation.

As a result of the unexpectedly quick mining and processing ramp up, the company has increased its first year (2014) production guidance to 1,000,000 pounds from their original estimate of 800,000 pounds. At this production level, UR-Energy will be producing 20% of the USA domiciled uranium production output.

A global low cost producer

The company is in the lowest cost producer quartile in the world with a direct operating cost of just over $16 per pound. Even their "all in" operating cost including ongoing development and full project capital cost recovery is just $32 per pound. Remember that most producers require a $70 price to be economic. The world leading production cost is mostly attributed to their In-Situ Recovery mining methodology, which is also a much more environmentally friendly mining methodology because it does not disturb the mining area as the name suggests. As a result of this operating cost advantage, UR-Energy will be generating significant cash flow next year even in this historically low uranium fuel price environment.

Significantly de-risked through long-term sales agreements

The company has secured approximately 50-60% of its production out to 2019 based on long-term pricing which is significantly higher than the spot price. As a result, it is estimated that the company's average selling price is currently ~$55 per pound. Also, most of these long-term agreements were negotiated a year or more ago when the long-term price was higher than it is currently.

Significant operating profit will be generated in 2014 as a result of high realizations and ultra-low operating cost

When one takes into consideration the double whammy of a high percentage of long-term pricing and an ultra low direct operating cost the company is set to deliver an operating profit before tax of ~$35 million or $0.30 per share at a 1,000,000 pound mining and processing output. Also the company is off to a shooting start since commencing production ramp up in August and is anticipated to produce at least 150,000 pounds during the ramp up period in the latter part of this year. This initial production will also contribute ~$5 million of operating profit on the final quarter of the year (if the company is able to achieve its cost estimates) which will further help the company to financially de-risk going into its first full year of production next year.

Significant de-risking of the balance sheet has just occurred

The company has impressed it current shareholders over the last year during mine and processing facility construction with it use of debt to finance construction and operating expense as opposed to taking the easy path of issuing shares and further diluting existing shareholders' equity holding. Finding debt for most mining juniors is a mammoth task but this company does not have typical management. The company is extremely well managed and directed and it partnered with the RMB Australia Holdings Limited for two loans to provide the required working capital to fund the completion of the mining facilities and pay operating expense. These higher cost loans were taken out to bridge the reception of a long awaited $34 million Wyoming State bond, which has very favorable terms. The great news the company just announced on October 24th is that this state loan finally made through all of the layers of bureaucracy and has been granted to the company. So now the higher cost loans have been paid off but the company is keeping one active to draw up to $10 million as necessary to further develop its other Wyoming properties to further increase its production output. One upcoming cost is the closing of its purchase of the Pathfinder property, which is currently owned by Areva (AREVA.PA) the French nuclear giant. The property is within the core of the company's Wyoming mining developing zone and will substantially increase the company's uranium resource. The purchase is expected to close in the current quarter.

The current cash balance is estimated to be in the ~$9.3 million range. The cash balance at the end of September was $6.3 million and the balance of their loans was $31 million at the end of the quarter as well. The securing of the new state bond facility of $34 million was immediately used to pay off both loans leaves leaving a $3 million cash balance to add to its end of quarter balance. There was also some origination fees on the loans that were returned to the company by the lender (due to the early repayment) as well as the canceling of some warrants.

The Investment thesis has two aspects:

The primary driver for this stock to resume it breakout and rise to the $2 level is the completion of the re-rating process of the company's shares as it fully completes its transition from a developer to a full fledged producer. Though the company is now producing, the market will be looking to see if the three levels of operating cost estimates (page 15 of company presentation) telegraphed by the company are achieved as well as the meeting of its quarterly production volume guidance for 2014. This is the company specific driver to double the share price. This company was a net cash burner for the last 9 years and has now transitioned to a cash generator. UR-Energy shares have been outperforming the industry over the last year as its superb management and direction have accomplished much:

Constructed a world class mine and processing facility in super geo-politically friendly Wyoming on time and on budget
Utilized debt for the bulk of the construction as opposed to continued dilution of equity (which is very shareholder friendly for a pre-production junior miner)
Utilized an ISR mining methodology with world leading low operating cost and an estimated 87% IRR for the Lost Creek project
Ramped up production quicker than expected and poised to produce 1 million pounds of fuel next year and generating ~$35 million ($0.30 per share) of direct operating profit (their current net debt is ~24 million pre closing of the Pathfinder assets) as well as an estimated $5 million from their production this fall if the cost estimates are met.
Used solid forward thinking to secure long-term sales agreements for ~50-60% of their production on a go forward basis in this uncertain market thus significantly de-risking the company
Stayed true to their word in achieving a very strategically beneficial loan facility from the State of Wyoming

The second aspect in this thesis is macro view with respect to the turnaround in the sector. This other necessary ingredient to fuel the rise in equity value is at least a moderate improvement in the macro environment where the uranium spot price gets back to around the $50 per pound level. Without some level of macro improvement, investors will be hesitant to buy into the sector. The sector sentiment must improve to add support to each of the company specific catalysts as they occur over the next year to eighteen months. This is seen by many market watchers as inevitable at some point in the late to early to mid term as the utilities begin to go to market to purchase more long-term supplies; this as a result of the Japanese reactors coming on stream and removing the psychological Japanese fuel inventory overhang as their utilities begin to consume this inventory. As the spot and long-term prices begin to move up, undoubtedly the equity values of the various explorers, developers and producers will begin to move up very rapidly. This as a result of their share prices being so depressed that any tangible sign of a trend change in the commodity will have a very positive impact. And as well we know as investors the leaders will get the investment dollars first so leading companies like Cameco and UR-Energy will lead the way up in a recovery.

The average price target for the company is $1.70 from the analysts that cover it and they also have an average rating on the stock of Strong Buy. If the company achieves their production and operating profit projections next year, the stock will be very undervalued trading at just 3.7 times 2014 direct operating profit. Also from a NAV view point, the company is trading at just 0.5 times its NAV so if it was trading at its NAV, the share price would be $2.20 versus its current $1.10 (at the time of writing) which is a double.

Investing in UR-Energy will require patience as it will likely take a while for the sentiment to improve and the coincidental increase in the uranium spot price. The stock had already broken out to the upside this past summer but began facing resistance earlier in the uptrend than it should have as macro level news concerning Japan's slower than expected plant restart process released over the last several months caused the commodity spot price to fall from the $40 to the $35 level resulting in the entire sector coming under selling pressure and UR-Energy's share price re-rating getting partially postponed.

The risks to this thesis (which are very important to consider when making an investment choice):

Macro

Commodity Price - though the uranium spot price is currently at an eight year low, it is conceivable that if the Japanese make the very unlikely choice of not restarting its plants and dump their large fuel inventory, the commodity price will stay at these levels for a much longer time frame. Though this will not hurt UR-Energy that much due to its hedging of a large portion of production pre-sold at long-term prices which are much higher than spot, the sentiment would take another blow and investors would hold off buying into these companies for a longer period of time (until more of the ~70 reactors under construction come on line).
Headline - Though it was hardly the fault of the Fukushima Daiichi plant itself that it failed (but rather an incredible 55-foot wall of water that inundated it), the plant melted down and consequences have been socially and financially huge. I do not believe the meltdown took any lives, but the inconvenience and financial cost to the Japanese people (who are already jammed on a pretty small island relative to their near 100 million person population) has been very considerable. A further incident such as this would put a spike in the sector's heart with no relief for some time to come

Company Specific

Production - The company does not achieve its production volumes thereby reducing its operating profit thus reducing the company's equity valuation
Operating Cost - The company does not achieve its direct operating cost estimates ($16 per pound for direct and $23 per pound including development)
Reserve Life - The company indicates an 8 plus year mine life at Lost Creek. There is a risk that the reserves were over estimated and the RLI is lower than previously thought
Liquidity - If operating profits are significantly impacted by volume or margins being significantly below expectations the company could develop a working capital issue

In my experience with this company, Wayne Heili and his management team have proven that they are world class over and over again and certainly have earned my trust and respect. They have developed the company into a very solid junior producer even within a multi decade sector depressed environment to the point that even in this environment the company is undervalued and a very steady investment. One other important factor concerning the company is that a very significant percentage of shares are in solid hands. BlackRock has a very large minority ownership stake in the company, which is a positive as a very significant volume of shares being in very steady hands.

Some Catalysts

Q4 report - this final quarterly report for 2013 will have the company's first production revenue reported along with the various levels of operating cost and margins as well as a fresh guidance for these and production levels for 2014. If they are on track with current estimates then this will put strong wind under the share price.

Commodity price - if the sentiment improves quicker than anticipated due to a number of factors (including reduced supply as a result of a major higher cost producer shutting in significant production or if the Japanese announce a fast track of reactor re-starts), the spot price will jump as well as the share prices of the miners (particularly those seen as leaders)

Reserves - the company is expected to report on drilling results prior to year end. A surprise to the upside with respect to resource and or reserves would be positive support for the share price

Buyout - UR-Energy has a brand new world class mine and processing facility with a 2 million pound initial capacity, which is in production within the heart of the USA (which is a severe net importer of the fuel that powers a large percentage of the nation's electricity generation). The company also has future development properties surrounding its Lost Creek producing mine. Along with the million pounds of production next year comes free cash flow and profitability. This is indeed a takeout target and the time for a major to acquire the company is now at the perceived low point in the cycle.

Conclusion

I see little downside to this story as a result of the high percentage of long-term pre-priced agreements and the ISR mining methodology with its ultra low direct operating cost, but if all heck broke loose the share price could get back to the 90-cent level a ~20% down side from the price at the time of writing. On the upside, if the company meets it production and margin estimates and the macro picture improves even moderately, I can easily see this stock price well over $2 per share in less than a year from now providing a doubling of one's investment.

The uranium sector may not be for everyone but neither was the solar sector after the European government subsidies started disappearing and the Chinese producers kept dumping production into the market and the producer share prices were decimated (and I mean decimated). But in retrospect, that was the time to buy... when sentiment was awful. Well sentiment toward the uranium sector is just as awful so this may (and I stress may) be the time to wade into the sector to take an initial position in a thriving, leadership company like UR-Energy ahead of the herd.