Looking At Uranium - What a hedge.

As an investor uranium has made me very uncomfortable. There is no question that there is a huge gap in supply and demand and that uranium mines take longer to get the approval process to build them than other mines, so there should continue to be a gap for some time, but it has all the appearance of a bubble.

So, I've been looking deeper into uranium because the spot is very, very, very high, and any one in a position to take advantage of that spot price is going to make a lot of money. The question is, have investors fairly valued the potential, under valued or over valued it?

So, I've been reading Cameco's management an analysis. Cameco has 513 million pounds of uranium reserves. At that spot price of $113/lb, well that's $58 billion dollars!!! And their market cap is only $17.8 billion US, fully diluted. And heck, they also have 100 million pounds of resource and another 316 million pounds of inferred resource. They also have 3.6 million ounces of gold reserves. And then they have the electrical part of the business.

Actually, the numbers do not excite me. Certainly if they were able to sell their uranium at those prices they would make so much money because the profit margin would be incredible.

But, these are things that I found. Much uranium is bought and sold through long term contracts. In 2006 the cost per kWh for energy produced from nuclear power was 1.66 cents, from coal was 2.28 cents, 6.60 for gas and 9.64 cents from petroleum.

So nuclear energy costs only 1.66c/kWh (average 2006) when spot prices are $49.60 (average 2006), right?

Wrong, time to choke, Cameco's average price was $20.62/lb, about 41% of the actual spot price. The industry tends to make contracts 2-4 years prior to delivery and have those contracts in place for 4-6 years. Cameco has 60% of its uranium hedged. Looking back to just 2003, well that was the first year the average spot price exceeded $11 US, that's the price range for 60% of it uranium. That's only about 90% short of the current spot price...

At $20.62 that 513 million pound uranium reserve is worth about $10.6 billion.

Currently their production volume is about 21 million pounds per year, and they have a fully integrated business in converting the uranium from what's pull from the ground to what nuclear reactors actually use. They actually ended up selling 32 million pounds, but they purchase other uranium concentrate, process it and then sell it. They do not gain from the bull run on uranium for those 11 million pounds.

It seems Cigar Lake had production commitments for 2007. It seems like these contracts at low prices are being extended for 5-7 years.

I didn't find guidance on the price of the hedged uranium, but it seems only an inflation increase is in order.

It sure changes the dynamics of what a stock might be when they are only getting about 10% of the current spot price for 60% of their production.

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Quote of the Day

It is interesting to note that when financial reports show a remarkable increase that is utterly due to unrepeatable events there is little said about what a poor indicator those reports will be of future performance. However, Cameco's president has said it well about how the problems they've had this quarter are a poor indicator of how their company will ultimately perform.

"Since Cameco's quarterly results vary significantly, comparing today's results to a remarkably strong first quarter last year is a poor indicator of future performance," said Jerry Grandey, Cameco's president and CEO."

EPS was 17c this quarter, about half compared to last year. It appears that Mr Grandey is suggesting earnings for the year should be in the $1.25-$1.50 range, but I haven't looked closely enough to really understand what he said with, "We expect our consolidated annual revenue to grow by nearly 50 per cent in 2007."

Cameco is in a position to really take advantage of the uranium bull when they get their flooded mine operational again. Whether that bull has the potential to meet their premium price of $52.58/share right now would require a careful analysis of their operations. Their price has jumped from about $36/share, 46%, last fall when I first looked at Cameco when their mine flooded. That is creation of about $6 billion of market cap. Revenues for Q1 2006 to Q1 2007 fell from $542 million to $409 million. Over a year it works out to about $2 billion in revenue for an $18.4 billion, without dilution, market cap company.

Uranium has definitely moved into bubble valuations for many companies, and many will plummet taking investors life saving with them. Right now it appears there is a lot of future valuation built into Cameco.

It would really require careful analysis to evaluate Cameco's potential. Because they are a producer, they are morely likely to actually make a lot of money on the uranium bull, however, supporting a market cap of $18.4 billion is a pretty tall order. Uranium is different from many other metals in that the approval process to build a new mine takes a lot more time, so it is likely it will take a long time for supply to balance out with demand, giving producers an incredible opportunity to make a lot of money. However, an unsustainable amount of money has poured into uranium stocks.

Tread carefully with this one and do some serious homework. $18.4 billion is a lot of market cap to support. It is likely 2008 earnings will go up as well, but this one is being valued at a P/E of 70 today. Catching up is a tall order.

http://www.canada.com/ottawacitizen/news/business/story.html?id=f5460ba7-7a0d-47ce-abc3-90eb4365cba2&k=18594

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