CCJ - Cameco: High Multiple But Prospects Are Hard To Deny

2023-11-03 10:54:10 ET

Summary

• Uranium demand is on the rise due to growing concerns about climate change and the need for nuclear power in achieving net-zero emissions.
• The development of new nuclear mini reactors and the shift away from reliance on Russia for energy supply are driving the demand for uranium.
• The market is still cautious due to limited past price fluctuations prevailing low prices.

Cameco Corporation ( CCJ ) is one of the world's largest uranium mining and nuclear fuel production companies. Importantly, given the current geopolitical environment, the company is headquartered in Saskatoon, Canada. Cameco has two segments: uranium mining and fuel supplying to nuclear utilities.

Uranium has been in a steady uptrend after a few new mining ventures were initiated over the past 13 years post-Fukushima. Currently, growing concerns about climate change are driving a budding renaissance of nuclear.

As the International Energy Agency ((IEA)) highlights in its World Energy Outlook 2022 (WEO 2022) if the world wants to hit a net-zero scenario by 2050, nuclear reactors will be constructed at four times the historical rate. This reflects modeling what's required to help with net-zero. The closer we want to get to 1.5 or 2 degrees of rising temperatures, the more nuclear is likely required. Cameco believes current supply falls short of estimated demand by quite a lot in the coming decades:

This tends to be very hard to model for next year, let alone decades into the future. I wouldn't be surprised if it turned out completely wrong. But with nuclear the building of power plants is such a giant and time-consuming project, the near-term demand modeling should prove relatively trustworthy. Worldwide there are 440 reactors, with 60 reactors under construction. Many existing reactors are indeed aging, but increasingly, governments are choosing to extend their lives as long as possible:

Building a new plant can take decades and cost around 14 billion euros, investing in a lifetime extension can be done for less than 1 billion euros and take place gradually by replacing aging components during regularly scheduled maintenance or refueling periods every 18-24 months.

Russia's invasion of Ukraine has led many countries to rethink their energy supply and needs. In the short term, countries have scrambled to cover energy needs without reliance on Russia. Many European countries also attempted to fill the void left by Russian gas simply. In the long term, a renewed reliance on Russia has become less likely, and that choice also makes natural gas a less attractive fuel for the intermediate future. Although it's relatively not as carbon-intensive compared to coal, in the long term, it doesn't cut emissions by enough. The conflict will no doubt lift all renewables, but it has also opened the door for Uranium.

Sure, nuclear waste is a problem, and some citizens reject this technology with a passion, especially in Europe, where the Chernobyl reactor meltdown impacted much of the continent and was widely discussed in the media. I do agree it is a problem. Here's what Rolls-Royce CEO told the British parliament :

Most nuclear waste is completely benign; it is steam. The high-level waste that people have a concern about, for the entirety of all the nuclear energy ever produced in the UK, which is the equivalent of 30 years of everybody’s demand, is about the size of a dishwasher tablet. The volume of what you are dealing with is comparatively very small. It is something we have dealt with and continue to deal with in the way it is stored and managed. As Tom said, that does not happen with any other energy source. The worst impact is that of greenhouse gases.

The way I view it by relying on nuclear power for another few decades we're trading an exponential problem for a linear one.

The pivot towards nuclear will be easier as a new generation of Nuclear mini reactors is arriving. Westinghouse is supposedly ready to build the AP300 as soon as 2027. Importantly it features a passive cooling system that would have prevented the Fukushima disaster. Westinghouse is 49% owned by Cameco . But there are lots of competitors coming to market. Nuscale Power should be building its first reactor in 2029; Rolls-Royce ( RYCEY ) has a design and intends to build hundreds of small reactors between now and 2050:

We anticipate selling many hundreds of these units between now and 2050. That is a business case upon which we have attracted the capital today and those investors who came to the table in November last year have done their analysis. We have done market studies and research, and with that cost competitiveness, there is a huge demand for this technology. That is the premise on which we are building the business.

To my surprise, there are over 50 firms that have a design and intend to come to market with reactors. Russia has one operating, and there are SMR's under construction in China and Argentina as well. Not everyone's favorite holiday destination, but I can imagine permitting went a bit more smoothly.

Data by YCharts

While demand for uranium is clearly on the rise, mapping the supply side is surprisingly challenging. Uranium isn't very scarce. That doesn't mean it is easy to mine it economically. Few people enjoy a uranium mine in their backyard, and although it can be done safely, this requires significant investment. As is usually the case with mining, the available reserves heavily depend on the prices. At much higher prices (think 10x), it can likely be extracted from seawater. Before the Fukushima disaster, there was something of a uranium bubble, where the price went to $135/lb. This led to additional higher-cost base mine construction (as usual in mining), and these were later mothballed again. Although new supply possibly coming online at higher prices, this generally takes some time. But it is important to the long-term health of the market, so it doesn't dissuade reactor construction.

There have been unique secondary supply sources in the uranium market. For example, after cold-war tensions eased up, there's been supply coming to market from dismantled nuclear warheads. Many of these programs and pacts were widely publicized in the past. In 2023, Russia's Putin suspended Russia's involvement in an important nuclear reduction treaty with the U.S. A secondary source that's also been drying up is reactors scheduled for shutdown. Often these are now getting extensions. Previously, they had been selling down excess inventory (given they were going to be shuttered) but now they need to get into the market to get fuel AND replenish reserves.

Suppliers, burned in the previous bubble, are still very cautious. They now require long-term contracts before expanding production or processing capacity.

A consistent supply of fuel is extremely important for nuclear energy producers. Turning these off and restarting them is very costly. In addition, the current reactors are so big, it is challenging to replace their output on short notice. The fuel cost is also very low as a percentage of the generation costs compared to the generation costs in natural gas or coal plants. Finally, the fuel doesn't take up a lot of space, which means it makes a lot more sense in this industry to stockpile fuel. When there are price slumps, utilities and sovereign reserves try to stock up, and if there are price spikes, well-supplied parties may let go of excess reserves. This helped me understand why the price development, outside of the 2007 spike, has been relatively smooth.

One thing that seems favorable to me is the fact that Cameco is buying in the spot market, as it views this as more favorable than delivering out of inventory. CEO on the most recent earnings call :

And so, we like the fact that with demand in the market, there tends to be stronger pricing to achieve in both our portfolio as well as our pipeline. So then, we always have the issue of how do we source these committed sales. Production is an important source of it. We carry an inventory, to deal with any production shortfalls like we have today. We will make purchases in the near term of the spot market for immediate delivery.

We will occasionally buy on the forward curve for delivery out into the future, and we can take delivery, of that material sooner if we need it. We have other tools in the toolbox including, as Tim said, folks have a lot of material parked, at our facilities and in some cases, we have the ability to borrow it.

All of that to say that we think about these sourcing decisions years in advance, not just weeks in advance, but years in advance. So, we will buy material in the market that's exactly, where we want to be at this point in the cycle. We are far from sold out from an overall contract portfolio point of view. We've got a lot of pounds that can be contracted out into that window that I talked about, late 20s to early 30s.

We obviously want that material contracted at stronger prices, and one way to achieve that is, to actually have some demand to deploy in the near term of the market. So this is exactly where we want to be. Nobody should be surprised by it. It is - an important part of that full cycle value capture that we talked about. So, I think great, great question, Gordon.

The firm also has quite a bit of operating capacity and is willing to commit to long-term contracts. My understanding is the firm has max 56 M lbs of production capacity (without greenfield development) and is currently committed to 32 M lbs. It appears the firm isn’t yet contracting out the remaining capacity because it isn’t yet getting the prices it believes it should. Utilities are conceivably not taking the offers yet because they’ve gotten used to the old post-Fukushima paradigm of low prices. There is an interesting talk between Mike Alkin of Sachem Cove Partners and Harris Kupperman of Praetorian Capital on the floor of the 2023 World Nuclear Association (WNA) where they discuss this dynamic.

With so much potential to lock up revenue and income for a long time, it is hard to see where Cameco could trade. This is even more difficult to say because it acquired the 49% stake in Westinghouse in 2022 for around $4 billion. Back in 2007, admittedly with fewer shares outstanding, the company hit an all-time high of around $55. But it never realized high operating profits or high revenue and a high multiple simultaneously. The high multiple in 2007 anticipated much higher earnings, and these materialized but multiples contracted. Anticipating lower future earnings correctly as well. After Fukushima in 2011, both went down and not without reason, as nuclear energy became incredibly out of favor. The entire sector trades at very high valuation multiples, indicating favorable prospects are not exactly a secret. Cameco actually trades on the modest end of the spectrum of names I pulled up on Seeking Alpha.

Cameco is definitely interesting to me here. The demand side for uranium is fairly clear years ahead. You’re getting the optionality that SMR’s will be a huge success along with that. Near-term Geopolitics are a tailwind for this industry as countries are much less likely to rely on Russia for long-term energy needs. The thesis is at least partially priced in. Cameco has been doing very well lately, but there appears to be room for it to run more. An important drawback is that any nuclear event could quickly cool this market for another decade or two.

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