LEU - Centrus Energy Corp.: A Play On The Nuclear Energy Market

• Centrus Energy is the first and the only licensed producer of HALEU for the government of the U.S.
• The company has a strong competitive advantage as a HALEU producer, especially with government agencies indicating a strong demand for the product.
• The strong pricing will be reflected in the company's future revenues as it engages in long-term fixed commitment contracts.
• The price targets indicate a potential upside in its share price, with HALEU's advantage making the stock a potential long-term multibagger.

Investment Thesis

Centrus Energy Corp. ( LEU ) has been extremely volatile since the pandemic, significantly outperforming the market in the previous 52 weeks due to a share price rally from August to November 2021. This resulted in the stock reaching an all-time high price of about $85.6 per share since its name change from USEC Inc. to Centrus Energy in Q3 2014.

The stock has trended downward since mid-November, losing about 35% value YTD, underperforming the S&P 500's loss of around 15%. However, recently the stock has been recouping in Q3, with an over 30% gain in July.

LEU has generated strong financial results in the MRQ with strong YoY growth. Even though there is room for improvement, the company is poised to post desirable financial results in the upcoming fiscal periods as the current pricing advantage reflects in its topline.

Additionally, the company's progress on its flagship HALEU project can become a major selling point of its long-term success if its arrangements with the Department of Energy proceed as expected.

Accordingly, I am bullish on the stock, especially given that the stock boasts an upside potential and has been gaining momentum since the start of the third quarter.

Revenue Stream Overview

Centrus Energy is an international supplier of nuclear fuel and services to the nuclear power industry. It generates revenue through 2 segments;

Low-enriched uranium: This segment supplies nuclear fuel components, including natural uranium, to commercial power plant operating customers. It accounted for about 86% of the MRQ and 77% of H1 2022 total revenue.

Technical solutions: This segment provides advanced engineering, design, and manufacturing services to government and private sector customers to power existing and next-generation reactors, deploying uranium enrichment and other capabilities necessary for producing advanced nuclear fuel. The HALEU contract is undertaken through this segment.

High Assay Low-Enriched Uranium (HALEU)

HALEU is considered an essential component for the advanced nuclear power plants to achieve smaller designs with more power per unit of volume, longer core lives, increased efficiencies, and better fuel utilization. Centrus iterated that nine of the ten advanced reactor designs selected for funding under the Department of Energy's Advanced Reactor Demonstration Program , including the two demonstration reactors, will rely on HALEU-based fuels.

HALEU has a concentration of the fissile isotope U-235 between 5% and 20%, much higher than the 3% to 5% concentration of low-enriched uranium, which fuels the existing light water reactors, but significantly lower than the 90% weapon-grade enriched uranium.

The global development of smaller, more flexible, and less expensive advanced nuclear power plants is rising , with more than 300 new Small Nuclear Reactors ((SMRs)) being deployed in the US over the next 25 years.

According to IEA , the global annual nuclear power capacity needs to reach 27 GW in the 2030s, and the total capacity needs to double to 812 gigawatts by 2050, up from 413 GW this year, to reach net-zero emissions. However, about 260 GW, or 63%, of global nuclear plants are over 30 years old and nearing the end of their initial operational licenses, meaning that much more capacity must be added than the required increment to accommodate the imminent decrease.

A report by UxC Consultancy for the NEI states that exports of nuclear energy equipment and technology required to meet the projected demand will create an opportunity of about $1.3 to 1.9 trillion for US firms by 2050. Accordingly, NEI estimates a demand of almost 600 metric tons of HALEU by 2030.

In 2021, Centrus became the only US company approved by the US Nuclear Regulatory Commission ((NRC)) licensed to produce HALEU. Centrus has constructed its sixteen AC100M centrifuges to demonstrate HALEU production under a 3-year $115 million shared-cost contract with the Department of Energy's ((DOE)) Office of Nuclear Energy as part of a long-term solution . As of date, DOE has incrementally increased the contract's total funding to $154 million.

The contract was set to expire in June 2022, but it was extended to November, with authorization to work through August 2022, because of a pandemic-related delay that resulted in the lack of an essential operational component. The scope of the contract has since been changed to move the operational portion of the demonstration to a new, competitively-awarded contract that would provide for operations beyond the term of the existing HALEU Contract.

The DOE has requested a record $1.8 billion for its Office of Nuclear Energy in FY 2022, including over $500 million to help demonstrate and mature a variety of US advanced reactor designs, most of which are HALEU-based.

The company posted a HALEU update in its MRQ results , stating that it has met all the previous milestones under the contract and completed a conceptual design for a commercial-scale HALEU cascade with 120 centrifuges, materially larger than the 16-centrifuge demonstration cascade. This would allow it to produce approximately 6 metric tons of HALEU annually.

LEU's hub for the HALEU project, the Piketon facility, is large enough to house thousands of centrifuges, leaving significant room for supply growth if the IEA's demand projections are taken at face value. The company's progress in this endeavor has given it a significant first-comer advantage and if it can stick to its dates, deliverable, and other commitments.

Financial Performance and Position

LEU's low-enriched uranium order book consists of long-term contracts that extend up to 2029, with fixed minimum purchase obligations, safeguarding the company against short-term volatility, especially given the current market uncertainties in the wake of the Russia-Ukraine conflict. It is currently valued at about $1 billion, including about $0.3 billion of deferred revenue paid by customers against future deliverables.

The company has noted that its price per separative work unit ((SWU)), which flows along with Uranium prices, has significantly increased since 2018 from $34/SWU and has risen about 55% since the start of 2022 from $56/SWU to $87/SWU. Since the company fixes its long-term contracts on the current rates, the higher SWU prices closed in present contracts are realized in future periods when the company fulfills its obligations. This means that the financial reports in the coming years will greatly benefit from the high uranium prices of this year.

The company's income statement showed strong YoY growth in the MRQ with robust revenue and profitability growth. Its topline grew by almost 60%, facilitated by a YoY growth of 136% in the average SWU price. The gross margin grew from 27.4% to 61.4% due to the strong topline growth and a $5.6 million cost reduction associated with the HALEU contract.

The company succeeded in carrying this profitability growth down the line despite a 17.5x growth in R&D expenses from $0.2 million to $3.5 million, resulting in a 30% operating margin growth from almost 19% to almost 49% and an almost 20% increase in the net margin from 17.5% to 37.7%. From top to bottom, despite a 146% increase in revenue per share, LEU's diluted EPS grew by over 317% YoY.

Investors should note that the nature of the company's contracts and revenue recognition makes it vulnerable to timing variations, which may result in inflated or deflated financial results. Accordingly, I have presented the TTM-based data below:

LEU had a substantial YoY cash reduction of $60 million, primarily caused by a 69% growth in its working capital, amounting to about $50.3 million. Its 1.47x current ratio indicates appropriate liquidity, but the company needs to improve its financial position as it holds long-term debt of $98.8 million, long-term inventory loans of $45.8, and current loans of $6.1 million, resulting in net debt of $35.1 million on its balance sheet.

The debt relates to its 2027 8.25% notes issued in connection with a troubled debt restructuring. Its interest payments are posted as a reduction in its carrying value rather than an interest expense. This is amply covered by the company's EBIT, but given the mediocre levered FCF margin of about 6% and the negative OCF and FCF per share, the company needs to augment its cash flows.

Valuation

The company is currently valued at 3.47x its TTM earnings and 15.84x its forward earnings, significantly lower and higher than the sector medians, respectively. This is because the company's earnings are prone to seasonal fluctuations, which result in unreliable relative valuation measurements.

Therefore, bundling up the forward and TTM-based relative valuation metrics together to extrapolate a price target outputs a much more reliable price tag, given the significant expected fluctuations.

The method indicates a fair share value of $51.53, 25% higher than the current share price. This is fairly below the analyst estimates of $59 per share, but I believe it presents a more realistic expectation, given that the share price has historically lagged analyst estimates and the economy is presently riddled with economic uncertainties.

Conclusion

Centrus Energy is improving its income statement and sports a healthy balance sheet, albeit needing improvements. Even though its current cash position is strong enough to maneuver through the turmoil of macroeconomic uncertainties safely, the significant pricing advantage has presented the company with a great opportunity to generate further cash and achieve financial statement augmentation.

It is uniquely poised to leverage the nuclear power market through its HALEU project and secure a firm footing in the advanced nuclear reactor market for the long term. The company's increased R&D expenditure and HALEU contracts are great indicators to monitor its future orientation. Investors should closely monitor its HALEU progress, which has the potential to make this stock a long-term multibagger.

Potential investors should consider that the stock is highly volatile, given the high 60-month beta of 2.32. However, with a strong momentum gained since the start of this quarter, I expect the stock to stay on this trajectory and realize the upside potential.

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