Are Cameco Shares Set to Soar?

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Uranium prices have been very weak over the past several years after skyrocketing just before the financial crisis of 2008 – 2009.  The uranium price started the 21st century at under $10/lb. only to skyrocket to well over $100/lb. before the financial crisis. Like other commodities, uranium collapsed during the crisis only to rebound immediately following it. However, with the price exceeding $70/lb. in 2011, we saw a new bear market develop as the Fukushima debacle created fear in the uranium market that we would see stricter regulation and a greater emphasis on forms of energy other than nuclear. This sent the uranium price down to $35/lb. where it sits today. This is the lowest level since 2005.

But despite the low uranium price, and despite the aforementioned fear that uranium demand would abate in response to environmental concerns, demand is rising as was expected prior to the Fukushima disaster. While there are environmental groups concerned about another Fukushima or Chernobyl governments throughout the world, especially in developing nations, nuclear power is a cheap and reliable source of energy that is safe if properly regulated.

Therefore, we see a disconnect between the uranium price, which sits at its lowest level in 9 years, and demand, which is rising steadily. The end result is that the uranium price has to move higher.

While there are several uranium mining companies for investors to choose from, most of them are small exploration companies or high-cost producers that cannot turn a profit at $35/lb. uranium. For investors looking for a uranium investment that is cash flow positive, has several producing mines, and pays a dividend, there is really only one option – Cameco Corporation (NYSE:CCJ).

Cameco Corporation is the world’s largest uranium producer. It has a market capitalization of nearly $10 billion. While it trades at a high multiple to earnings — about 33-times trailing earnings — investors have been bidding up the shares in anticipation of a rebound in the uranium price.

Cameco is set to do extremely well should the uranium price rise. The company is set to produce about 24 million pounds of uranium next year at just under $30/lb. While the uranium price is about $35/lb., the company has contracts in place so that it will receive a substantially higher price between $45/lb. and $50/lb. This means that the company will earn about $360 million in 2014. But according to the terms of Cameco’s contracts, if the price of uranium rises, so will the company’s realized price. For instance, if the price rises to $80/lb. the company will receive $62/lb. Thus, not only is the company protected from further downside price action, but it will benefit should the price rise.

Looking further into the future, the company’s realized price will be closer to the spot price as its existing contracts expire. While one could argue that this leaves the company vulnerable to downward price action in uranium, we find that going forward the supply deficits in the uranium market become more acute, and this will lead to a rising price in order to incentivize further exploration and the mining of lower grade uranium ore.

With that being said, Cameco is extremely well-positioned to benefit from the rising supply deficit in the uranium market. It will be profitable in this weak price environment, and it can use these profits to not only pay dividends (the company currently pays $0.40/share per year) but it can pay to expand its operations or to buy out its smaller competitors that cannot operate profitably in the current market.

Therefore, with a supply deficit in the uranium market and with the uranium price sitting at a 9 year low, I think prices could be set to rise substantially in the coming months. Cameco will be a clear beneficiary, and as a result, its shares could be set to soar. Investors looking to take a position will find that the shares are already up by 17 percent this year, and that it might be best to wait for a pullback. Uranium producers — Cameco included — saw a spike in their share prices at the end of February, and I suspect that we will see some consolidation.  Interested investors should consider taking a position at around $22/share, which is about a 10 percent discount to the current share price.

Disclosure: Ben is long Cameco Corporation.

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