SMR - NuScale Power: Mixed Feelings About This Stock

2023-08-28 14:51:57 ET

Summary

• NuScale Power Corporation's SMR technology offers a flexible and adaptable solution for nuclear power generation, with lower upfront costs and increased safety measures.
• The company could receive another SDA by the end of FY24 which would make its tech more cost competitive.
• The company faces financial risks, including declining cash balance and potential political sensitivity to funding. Investors should also consider the long gestation risks and track record of the nuclear industry.
• Revenue which is currently largely being driven by licensing fees is poised to grow at a rapid pace and makes the stock look cheap from an EV/sales angle.
• However the technical conditions, don't look too appealing.

SMR - What’s To Like

Before we get to the specifics of NuScale Power Corporation ( SMR ), it’s worth touching upon the potentially important role that nuclear power may play in helping the globe hit various decarbonization goals through 2040.

According to BloombergNEF , meeting these long-term climate targets would likely necessitate the addition of at least 16KGW of carbon-free generation capacity. Competing tech such as hydroelectric, solar, and wind could play a part in helping us get there, but given nuclear power’s inherent dependability (regardless of seasonal shifts) and low maintenance needs (refueling only takes place every two years or so), it is difficult to imagine a scenario where nuclear isn’t valued. For context, note that relative to other energy sources, nuclear tech typically generates the highest amount of power output for a given capacity (92.5%).

Now, developing and expanding traditional nuclear tech infrastructure is no mean feat, particularly when you consider the elevated cost considerations and the intricate complexities involved. That’s where NuScale Power Corporation’s flexible SMR (Small Modular Reactor) technology could have an edge.

As implied by the term-SMR, the generating capacity of these units is much smaller (at best, they typically only generate a third of the total capacity of traditional reactors) and there's an inherent flexibility and adaptability that lends itself to use across multiple applications in a cost-effective manner.

For instance, you could have a scenario in an underdeveloped terrain, where grid capacity reach is stunted, rendering large reactors redundant; SMRs could be easily deployed here at a low-scale (perhaps just one module), and then, things could be scaled up over time (up to 12 modules). The relatively lower upfront costs could also attract a wider pool of clients. Another crucial edge that SMRs offer is that refueling only takes place every 3-7 years, and besides that, these reactors rely on passive systems and don’t need human intervention, bringing an additional degree of safety.

Note that SMRs can be fuelled in different ways (gas, molten salt, etc.) but NuScale uses a proprietary light-water cooled tech which the World Nuclear Association believes has the lowest technological risk . NuScale also appears to be ahead of the competition as its 12-module SMR is the first and only product to receive Standard Design Approval ((SDA)) from the US NRC (Nuclear Regulatory Commission). Getting this approval wasn’t a piece of cake, and took over three and a half years to come to fruition.

Needless to say, this stamp of authority has certainly enhanced the credibility of NuScale’s tech in the eyes of potential clients involved in activities such as electricity generation, hydrogen production, heating, desalination, etc. The company believes that its current customer pipeline consists of over 120+ opportunities across the globe with at least 10-15 customers considering plant deployment by the late 2020s or early 2030s

The next biggest catalyst could come by the end of next year, if the US NRC approves NuScale’s SDA (Standard Design Approval) to raise the licensed output of its power modules from 50 MWe to 77 Mwe. Acceptance of this review took place last month, and if design approval comes through, the company could have a more cost-competitive product that would appeal to a wider pool of customers.

Risks

As you can imagine, building and scaling a business of this sort will require a lot of capital, particularly given the tremendous overheads witnessed across periods. Just to highlight the status-quo, management believes this is an asset-light business, so CAPEX may not be intense, but you’re still looking at a business that guzzles around $30-$45m of operating cash flow per quarter. Already on a YTD basis, the company's cash balance has declined by 52%, and at the current cash outflow run rate, it looks like the company could run out of cash in four quarters.

Note that in recent years, a substantial chunk of the funding has come from cost-share grants provided by the DOE (Department of Energy), and this in turn, can be very sensitive to the political hues at any point in time, which is certainly not ideal. In addition to that, there typically are certain subscription targets that need to be met within certain periods, failing which SMR will need to reimburse UAMPS (Utah Associated Municipal Power Systems) - its first customer. Investors should also brace themselves for ample dilution risks with the company going for a $500m mixed shelf in early June.

Given the long gestation risks involved in the nuclear arena, this story is clearly only meant for buy-and-hold type investors with infinite reservoir of patience. Just for some perspective, note that the flagship VanEck Uranium and Nuclear Energy ETF, which focuses on 30 nuclear stocks including SMR has been a massive source of wealth erosion since its inception (down by -47%) and hasn’t really gone anywhere over the last decade. This narrative could well change, given nuclear’s growing clout in attaining climate targets, but the track record so far can certainly make one wary about investing in this space.

Closing Thoughts - Valuation And Technical Commentary

Having said that, we'd like to think that SMR's stock may well attract the attention of bargain hunters on the lookout for beaten-down names from the nuclear universe. The VanEck Vectors Uranium and Nuclear Energy ETF focuses on stocks that generate over half their revenue from nuclear energy. The image below tells us that SMR looks very overextended to the downside relative to its nuclear peers, with the relative strength ratio currently trading at record-lows and over 50% off the mid-point of its range.

Then there’s also the valuation quotient to consider and the growth potential you’re getting at the current multiple.

Looking at SMR from a P/E angle is pointless as it will likely generate operating losses at least for the next three years, but if one is prepared to look at this business purely on the basis of the topline dynamics, it does not come across as prohibitive.

Just to reiterate once again, SMR’s topline as it stands is not yet driven by any equipment sales, but rather, through licensing fees and front-end engineering services. This may not quite be SMR’s core ambition, but don’t write this off, as the pace at which these types of sales are expected to grow is still quite impressive. If one looks at YCharts estimates (based on four analysts) over the next two years, you’re looking at a business that could provide topline growth of 234% on a CAGR basis.

Normally, for such elite levels of forward topline growth, you’d expect a pricier EV/sales multiple, but based on the FY24 EPS, SMR is priced at only 1.9x, a 70% discount to its long-term average.

However, if one looks at SMR’s weekly price action over the past year, it doesn’t fill us with a great deal of confidence. The overriding takeaway here is that of a fairly consistent descending channel, with the price failing to break past the upper boundary of the channel, despite multiple attempts at building a floor.

Most recently, in late June, it looked as though the price action was flattening out over 6-7 weeks, providing the foundation for a breakout, but rather what we saw was a breakdown last week with a large-bodied red candle. Based on the risk-reward within this channel, it does not look like investors would be best served jumping in as the price is still closer to the upper boundary of the channel.

Also consider that the short-selling bandwagon only continues to gain confidence, with the short interest on the stock recently rising to record highs, as the percentage of the float sold short hit almost 22% ! When bearish conditions are on a roll, investors would be advised to not display unnecessary bravado and jump in, but rather wait for the selling to subside.

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