Ur-Energy – Improving Financial Position

Financial position: a concern’s ability to have and to create liquidity (either from surplus cash or from other assets readily convertible into cash, such as a portfolio of blue-chip corporate stocks and bonds whose resale is not restricted); by an ability to generate surplus cash from operations; by an ability to borrow; or by an ability to market new issues of equity securities        Martin J. Whitman

So what of Ur-Energy’s financial position?

We witnessed their evolution from a developer to producer and now they sit on the precipice of profitability.  Heili’s team transformed the barren hills of Lost Creek into a proverbial uranium mine. It took nine long years to get here and I suggest reading the Lost Creek NI 43-101 (http://www.ur-energy.com/technical-reports/) to fully appreciate the journey or if you have any doubts about their ability to execute the project plan.  I like the way management runs the company: contracts for 30 to 50 percent of uranium production were negotiated far in advance.  The Lost Creek ISR mines and processing facility were completed on schedule and within budget.  These contracts can provide positive cash-flow, but the real money will be made when they sell the remaining U3O8 under more bullish conditions.  Mr. Heili has played his cards well and shareholders should profit handsomely when that day comes.

I assure you, no one at Ur-Energy (URG) is reaching for the cigar case.  Pathfinder, with its estimated 15M pounds of uranium, is high on the radar and will be the next target:

“Internal historic reports prepared by Pathfinder estimate the presence of remaining resources at the two projects totalling approximately 15 million pounds U3O8.  These historic reports estimate that the Shirley Basin project holds over 10 million pounds U3O8 at a GT (grade-thickness) cut off of 0.25 ft%.  The average grade reported for the property is 0.21% U3O8.  Lucky Mc holds an additional 4.7 million pounds U3O8 at similar grade.” (http://www.ur-energy.com/2013-news-releases/)

The challenge will be raising the estimated $46 million for development. They can draw arrows from debt, equity financing, revenue, or a combination thereof, but how full is the quiver?  In this article I will present a modest earnings forecast to analyze the impact of positive cash-flow on the company’s financial position.  We know conditions will improve, but to what extent and how will this translate into funding for Shirley Basin and “Lucky Mac”?

Improving Market Fundamentals

The current spot price of uranium is a dismal $35 per pound, but any rational investor will conclude a correction is brewing.  The Japan Times staff writer, Kazuaki Nagata, reported that TEPCO just got approved to restart reactors 6 and 7 at its Kashiwazaki-Kariwa nuclear power plant in Niigata Prefecture this summer.  With all reactors running, this facility produces 7,965 MWe, making it the second largest power generating facility ever built; the Three Gorges Dam in China produces 22,500 MWe. He said there’s a good chance that units 1 and 5 will be added to the list by the end of 2014 and, “Restarting one reactor would cut between ¥100 billion to ¥145 billion in operating costs, according to Tepco.”  Clearly there is tremendous financial incentive for utilities to restart, but Japanese heavy industry is in the same boat as high energy costs cut deep into their profits.  Japan is now importing almost all of its energy and paying a premium for it.  This is bad news for a country that sees itself as an industrial exporter and whose government no longer has a blank check when it comes to nuclear energy.

While Japan struggles to recover the F-14, China looks to be the real top gun.  There are countless reports that paint a very bullish picture for Chinese reactor construction and I consider that money in the bank, but often overlooked is their desire to go global.  In late December, they broke ground in Karachi, Pakistan for a US$9.59 billion nuclear power facility and there is more to come on that front.  England opened the door as well; China General Nuclear Corp and China National Nuclear Corp will put up a reported 30 to 40 percent of the cost to build two nuclear reactors at Hinkley Point in southwest England.  England has plans to build twelve more reactors; China will be a major investor and technology partner in the British Nuclear Power program.  There’s a long list of countries seriously considering nuclear energy: Iran, UAE, Turkey, Vietnam, Belarus, Poland and Jordan to name a few.  To get a complete perspective I recommend reading the World Nuclear Association’s website (http://www.world-nuclear.org/info/Country-Profiles/).  China knows this and they are poised to become a major exporter of nuclear power.  I believe this development, in parallel with their domestic program, will provide the catalyst we need for a sustainable uranium market.

Benjamin Graham said that corrective forces are always at work in depressed markets; even in a prolonged down turn.  This sentiment is being echoed by many industry experts, including URG Executive Director, Jeff Klenda, who said in his interview with Lazarus Capital Partners, “And as the old saying goes, the cure for low prices is low prices.”

References:

Future Funding Requirements

On a call with IR Director, Rich Boberg, I asked if Lost Creek could serve as a baseline for Pathfinder’s development costs.  He estimated that total costs would be 70-80 percent of Lost Creek’s, but cautioned that the geologic team needed to compile and confirm the drilling data before any official guidance could be given.  The total project cost for Lost Creek was $58.1 million according to their Q3 MDA:

“Construction of the processing plant and maintenance facility has been completed along with development drilling in Mine Unit 1. Innovative design and development have focused on employee and environmental safety, recycling of water, chemicals and production materials, and advanced instrumentation monitoring and data capture. The Company has incurred $58.1 million to date in construction, equipment purchases and wellfield development costs through September 30, 2013.”

80 percent of US$58.1M gives us an estimated development cost of US$46.4M for Shirley Basin and Lucky Mac.  Rich said they would need at least a year to get the permitting done, so in theory they could break ground mid-2015, with production coming online mid to late 2016.  Now this is where it gets interesting.  Raymond James estimates U308 prices to be US$70 per pound in 2016.  Using Lost Creek as a baseline, it’s reasonable to assume Pathfinder production will be in the neighborhood of 1 million pounds per year.  If they secure contracts for 100 percent of production at an average price of $70/lb with all in cost at $29/lb, net income for the project is $41 million or 27 cents per share.  So in theory, if we spin the clock forward three years, Ur-Energy could be operating two ISR facilities, each producing 1M lbs per year with sales agreements in place at an average price of $70/lb.  I know this is simplistic, but the point is this; all the business has to do is stand up another ISR mine and processing facility to nearly double earning power.  I don’t know about you, but I like those odds.

So where will URG get the est. 46 million?

Uranium prices will greatly influence how they break from the huddle, but CFO Roger Smith could use the next 12 to 24 months to strengthen the company’s cash position so that cash plus further borrowing ability can cover the Pathfinder project cost.  The company is not shy about equity financing, but it would be prudent to do so when stock prices are much higher.  Consider the following comment by Phillip Fisher:

“If it is, and if the company is willing to borrow to the limit of prudence, the common stock investor need have no concern as to the more distant future.  If the investor has properly appraised the situation, any equity financing that might be done some years ahead will be at prices so much higher than present levels…  This is because near-term financing will have produced enough increase in earnings, by the time still further financing is needed some years hence, to have brought the stock to a substantially higher price” (Common Stocks and Uncommon Profits, p.74)

So the best case is for URG to use cash plus debt to cover the Pathfinder project; that being said, equity financing in the proper context won’t hurt.  Investors buying @$1.30 per share will hardly notice a modest stock issuance north of $3, especially one that doubles revenue in the long run.  The company could take its medicine up front and expense a significant portion of the project, but revenue would have to reach Jurassic Park levels to make this practical.

URG will have no problem covering the $7M in annual interest and principal payments for the State Bond Loan.  That aside the company can focus on building its cash position with cash-flow from operations as it prepares for the Pathfinder project.

Projected Earnings

In a September press release, management announced that the Lost Creek production rate was exceeding expectations:

“The Lost Creek facility recently surpassed a daily recovery rate of 2,200 pounds of uranium oxide (U3O8), which is equivalent to an annualized production rate of over 800,000 pounds.  The process flow rate through the recovery plant circuits is currently sustained above 1,800 gallons per minute.  The flow is derived from three header houses in the first mine unit area.   Additional header houses will be brought on line when needed to sustain the targeted production rate.”

They later state that the Lost Creek processing facility has a 2 million pound “boiler plate” capacity with 1 million pounds planned per year.  Given that production is exceeding expectations, I’ll take management at their word and assume they can deliver 1M pounds per year as planned.  The current spot market price of U308 is $35; however, Cantor Fitzgerald forecasts that uranium spot prices will average $43.25 for 2014 on the basis that 6 to 8 of the 14 Japanese reactors awaiting approval will be restarted by the end of this year.

Revenue assumptions for 2014:

  • URG will meet the 1 million pound production target
  • 50 percent will be sold at an average rate of $62/lb.
  • The remaining yellowcake will be sold at average rate of $43.25/lb.

Now for expenses:

“The economic analysis estimates the Project will generate net cash flow over its life, before income tax, of US$319.7 million.  It is estimated that the Project has a calculated Internal Rate of Return (IRR) of 74.5% and a Net Present Value (NPV) of US$198.3 million applying an eight percent discount rate.  The estimated operational cost for the project is US$11.54 per pound of uranium produced, while the total cost of uranium production including severance taxes and operational and capital spending is estimated at US$29.13 per pound.” (http://www.ur-energy.com/2013-news-releases/)

The estimated “all in cost” of production is $29.13 per pound with operating expenses estimated to be US$11.54 per pound.  We will use $29.13 per pound, since it includes both the capitalized costs and operating expenses for Lost Creek.  The numbers come from the revised Preliminary Economic Assessment (PEA) for Lost Creek and they represent a 20 percent drop from previous guidance.  Lastly, management indicated in the Lost Creek PEA that revenue from production may be used to fund additional delineation and exploration drilling.  The goal is to bring “inferred” resources into the measured or indicated category.  No guidance has been given so I’ll use last year’s exploration and evaluation number: $3.2 million.

  • All in costs are US$29.13 per pound
  • Exploration and evaluation expenses are US$3.2M

 

Basic earnings model:

Projected Earnings – FY 2014
U308 Production 1,000,000
Cost per pound $29.11
Exploration and Evaluation $3,285,447.00
Average Price (U3O8) $52.00
Gross Revenue $52,000,000.00
Total Expenses $32,395,447.00
Net Income $19,604,553.00
Shares Outstanding 144,000,000
Earnings/Share $0.14
PE Ratio 20
Share Price $2.72
Shareholders Equity $60,728,782.00
ROE 32.28%
Net Profit Margin 37.70%

 

A survey of PE ratios for uranium stocks gives us a range of 18 to 33.  The uranium giant Cameco (CCJ) is trading at a multiple of 28 to current earnings.  I’m using 20 to be conservative.  Our model produced the following results:

  • 2014 earnings @ $19.6M or 14 cents per share.
  • 2014 market price @ US$391.7M or $2.72per share

If the spot market continues to languish throughout 2014, URG might take an inventory position with the remaining 50 percent of U308.  This would push our timetable further out, but the company could unload its inventory under much more favorable conditions.  Let’s look beyond 2014 to 2015, 2016, and finally 2018 with both Lost Creek and Pathfinder in production.  We’ll throw in another 10M shares outstanding to account for potential equity financing:

Projected Earnings – FY 2015
U308 Production 1,000,000
Cost per pound $29.11
Exploration and Evaluation $3,285,447.00
Average Price $60.00
Gross Revenue $60,000,000.00
Total Expenses $32,395,447.00
Net Income $27,604,553.00
Shares Outstanding 154,000,000
Earnings/Share $0.18
PE Ratio 20
Share Price $3.59

 

Projected Earnings – FY 2016
U308 Production 1,000,000
Cost per pound $29.11
Exploration and Evaluation $3,285,447.00
Average Price $70.00
Gross Revenue $70,000,000.00
Total Expenses $32,395,447.00
Net Income $37,604,553.00
Shares Outstanding 154,000,000
Earnings/Share $0.24
PE Ratio 20
Share Price $4.88

 

Projected Earnings – FY 2018
U308 Production 2,000,000
Cost per pound $29.11
Exploration and Evaluation $3,285,447.00
Average Price (U3O8) $70.00
Gross Revenue $140,000,000.00
Total Expenses $61,505,447.00
Net Income $78,494,553.00
Shares Outstanding 154,000,000
Earnings/Share $0.51
PE Ratio 20
Share Price $10.19

 

Final Thoughts

My earnings model intentionally lacks precision because the goal is to establish a range of values verses some precise figure.  With that in mind, here are some takeaways from this report:

  1. If uranium spot prices stay depressed for a couple more years, there is modest upside, but we really just stay where we are until things heat up.
  2. If uranium spot prices reach the forecasted $70/lb in 2016, the company will experience a dramatic increase in earnings and market price.
  3. If uranium spot prices climb beyond that, Ur-Energy will go gangbusters.

Ur-Energy is in a satisfactory financial position:

  1. The company can position itself to use cash plus further borrowing to cover the cost of developing Pathfinder.
  2. A second option is equity financing—it is our view that this should only be executed at a much higher stock price.
  3. Lost Creek revenue can be used to fund the Pathfinder project.  This scenario would only be practical in a very strong price environment for U308.  It would cut deeply into earnings for a while, but there would be a windfall of profits at the end.
  4. The company can combine all three or use several combinations thereof to meet its funding requirements.

Financial position is the tool we use it to gauge risk and to assess the growth-potential of a business.  Ur-Energy’s position has improved and should continue on an upward trend as they become cash-flow positive.  I recommended buying shares of URG when the stock price was $1.13 per share and this strong buy rating remains in effect; it now trades in a range of $1.30 to 1.48, but the stock is still deeply discounted to intrinsic value.  There is plenty of safety and upside from here.

Graham said the intelligent investor should not seek profit by any means of prophecy.  We don’t believe in capitalizing hope, but we like to buy well-managed companies with good economics and favorable future prospects; especially when they’re as cheap as this one.

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