URG - Ur-Energy Inc.: The Production Ramp Seems Achievable

2023-11-17 09:46:41 ET

Summary

• The uranium market is experiencing a resurgence due to a re-focus on uranium as a green and efficient source of baseload energy.
• Ur-Energy has entered into several agreements for uranium production and has a feasible production ramp-up plan in place.
• Further upside exists beyond the Lost Creek production that the market is not yet pricing in.

Ur-Energy Inc. ( URG , URE:CA ) is an in-situ uranium developer and producer based in the United States. The company has a long history of producing uranium using its ISR (in-situ recovery) technique. The uranium market had been in a substantial decline after the Fukushima disaster in 2011, combined with a focus on renewable energy driven by proponents and governments focused on the "climate change/global warming" hypothesis. Over the last couple of years, the reality of these policies combined with rising global tensions in numerous locations around the world, have led critics and governments to re-examine their energy policies and uranium's place in it. In this article, I want to focus on the recent sales contracting and production for URG and how this compares to the company's current market value. A good question raised by Gold Panda in their article on the company helped to support this analysis.

Baseload Contracting

Uranium purchasing can basically be done in two major ways: through long-term contracts or in the spot market. For most of the last decade, it has been extremely profitable to purchase uranium in the spot market as it lay in the $20 to $30 per pound price range, well below the cost for most miners. This served to basically work off inventory that had been accumulated in several ways. The side effect was there was no economic incentive to either produce uranium or explore for it which helped to normalize the supply levels to meet demand. It has now left a dearth of supply available.

With the re-focus on uranium as both an efficient and green source of baseload energy, the entire uranium industry has now come into focus. This has been driven by a massive run up in the uranium spot price to the current level of $74 per pound, with the futures curve heading out even higher. This is making it profitable again to produce even for the spot market. However, sourcing material from the spot market doesn't provide much security for either the users (reactors for example) of the material or for those producing it should the price levels reverse. This desire for some certainty leads to long-term contracts being negotiated which gives cost certainty to the purchasers and a base level to encourage production for producers.

URG has now entered into several agreements which it has given the annual production requirements for as well as the contracted price:

URG management has been a producer in the past and has indicated that they could mine 1.2m pounds annually at its Lost Creek mine with another 1.0m pounds at Shirley Basin, with an upside production ability of 2.2m pounds annually. Gold Panda points out in their article that there is some risk should URG not be able to meet its contracted requirements from its own production, so it would need to acquire material in the spot market, which would produce losses in the current environment. Let's look at the current production ramp up plan compared to these current contracted amounts.

Production Ramp Up

Management made the decision late in 2022 to start ramping up production, which led to the commissioning of Header House H2-4 in May 2023 and HH2-5 in September 2023. These header houses produce roughly 120,000 lbs per year, based on inferring initial production results from Q3 2023 of 30,000 lbs as well as management's guidance for eventual production levels. In the company's recent 10-Q, it also indicated that two more header houses, HH2-6 and HH2-7 are nearing completion, while HH2-8 is beginning construction. Based on the company's communicated production levels and the above assumptions, it looks like URG can set up to 10 header houses. I ran an exercise to look at what the company has on hand for inventory, a staged implementation of header houses based on the roughly 1-year timeline to go live as well as the disclosed development information to see if they run a risk of non-delivery on its currently contracted requirements:

Based on this staged implementation, it appears that the current inventory levels combined with a staged production ramp give URG enough of a buffer to meet requirements and if the pace of the ramp up of new header houses continues, it will provide excess capacity by 2026. There is execution risk or force majeure supply chain risk like we saw during COVID that could impact this plan. I believe management's track record of production, its retention of key staff and its most recent performance of getting the first two houses online should give us some comfort that these timelines will be adhered to.

We don't know now of there is any future contracting above these levels. In its Q2 conference cal l, management provided the following guidance on how it would ramp production:

Mike Kozak

That's great. And that kind of dovetails into my second question, which was you added the 100,000 a year to the contract book in Q2. So my question was what level of contract coverage would you want to see before you kind of fully commit to the, call it, 1 million to 1.2 million pound per year of full licensed run rate at Lost Creek? Do you want to get like the fully 1 million a year contracted or 75% of that, 80% of that, how should I think about that coverage?

John Cash

Yes. So it's always our objective to match production at Lost Creek and ultimately at Shirley Basin with our contract book . So if we're contracted out at 900,000, that's what we want to hit. We'll probably try to give ourselves a little bit of buffer there, maybe 5%, 10%, 15% buffer. That way if we run into any challenges, regulatory, wildlife, you name it, that we've got a little bit of inventory that we can rely on, and we like having that overage.

But really, we're going to try to hit that contract number fairly closely going forward. And that's also true as we move into Shirley Basin. We'd like to sell effectively max out production at Lost Creek and then begin to contract out for production at Shirley and justify the ramp-up there as well.

I believe that URG's ramp up plan seems to be achievable based on past performance and its current trend. Of course, nothing is certain, but the major risk of non-performance would likely be some sort of exogenous event i.e., COVID rather than being company specific to URG.

Valuation

I ran a base valuation including just the current contracted amounts, the communicated gross margin percentage of 40%, operating costs at 20% of revenues (similar to 2015's level) and an addback of $3.6m for non-cash expenses. I came out with a peak EBITDA of $12.3m:

Even with any sensitivities, this puts the company's current EV to EBITDA ratio based on this at around 30x. This is expensive by any metric, so the market is clearly pricing in some additional contracting. I then modeled out if the company was able to sell surplus production at spot rates based on the current pricing curve (using averages for each successive year) as a proxy for new contracting. I also assumed that Opex would reach a critical mass in 2025 and then escalate at 6% (for inflation) after that. I assumed the company would reach peak production of 1.2m pounds in 2027 based on the staged implementation the company has done so far.

This would seem to indicate that the market is pricing in some of this growth at Lost Creek but not all. it also doesn't include any contracted amounts related to Shirley Basin or any exploration upside that the company could decide to pursue.

There are risks of course. We could see a reversion in the price environment, though the lack of near-term supply options makes this unlikely. The company could also have the previously mentioned operation risk in implementing this ramp up, though I noted why I think this lightly. There is also a chance that they are not able to get the pricing we hope for in the next set of long-term contracts or even get any further contracts at all. Being a domestic producer during a period where globalization is breaking down should buffer it, but frankly it depends on free market. I believe the macro environment sets up positively for uranium in general but others have detailed this at length, including in the company presentation .

The Takeaway

The risk reward at this point clearly is not as good as it was back in late 2020 and early 2021 when even the base case was not being priced expensively. Since then, shares have tripled while the spot price is up close to 300%. I do believe URG does give more safety than most explorers as it will have some actual cash flows to back up its valuation while the explorers will be years, if not decades, away from production and thus more speculative in nature. URG has the upside to be considered from the Shirley Basin resource, along with likely participating in any further escalation in the spot price.

Thank you to Gold Panda for raising this production risk and providing a good counter point to this article. I would encourage you to give the account a follow.

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