UEC: Uranium Energy Corp. and the Anticipated Uranium Industry Renaissance

Zacks Small Cap Research

By Steven Ralston, CFA

NYSE:UECNYSE:CCJNYSE:BHPNYSE:RIO


Summary
     -Uranium industry setting up for an anticipated recovery
     -Investors should be closely monitoring the uranium space to take advantage of this opportunity

     -Uranium Energy Corp. (UEC) is unique among junior uranium producers and positioned to provide a leveraged opportunity to participate in the upswing in uranium prices

Background

Just prior to the accident that occurred in March 2011 at the Fukushima Dai-Ichi nuclear facility in Japan, the uranium industry was experiencing a period of increasing demand with spot triuranium octoxide (U3O8) prices having just rallied from $40 per pound in early 2010 to slightly above $72. The accident created a supply-demand imbalance, which adversely affected both the nuclear and uranium industries. Immediately, China announced a moratorium on nuclear projects as the country’s nuclear safety practices were reviewed. Japan began shutting down its nuclear reactors for safety reviews, and by June 2012, not one of its 48 reactors was in operation. Germany shut down eight of its 17 nuclear power units.

 Uranium stocks, from major producers to junior exploration companies, sold off sharply after the Fukushima accident as the demand for uranium waned. Initially, spot U3O8 prices declined from $72.50 to around $50.00 per pound. Demand for uranium from Japan, Germany and Switzerland weakened, and some uranium producers canceled developmental projects and/or closed producing mines as the price of uranium declined. In 2013, U3O8 spot prices averaged $38.45 and closed at $34.40 falling 21% for the year. Today, U3O8 is trading at $32.50. However, at some point, demand will begin to outstrip supply, and investor sentiment will improve. The rebound ought to be very robust as long-term demand requirements for uranium are expected to rise.

The Uranium Industry

The uranium industry is setting up for a classic commodity supply-demand imbalance. Currently, the spot price of U3O8 is below the marginal cost of production of most of the world’s producing mines. At some point, this uneconomic situation will be corrected by either the industry rationalizing capacity and/or demand increasing, either or both of which will result in a substantial increase in the price of uranium. The structure of the industry is amenable for a period of disequilibrium that will exhibit significant price movement.

On the demand side, 434 operable nuclear reactors in 30 different countries crave supply, and globally, the number of operating nuclear reactors is slated to increase with 72 new reactors under construction, 173 on order or being planned and 309 being proposed, according to World Nuclear Association.

In Asia, Japan is expected to restart several reactors in the near-future with any new nuclear plants being third generation (Gen III) facilities. In December 2012, the Liberal Democratic Party won the general election. The prior government (the Democratic Party of Japan) sponsored the phase out of the use of nuclear power. However, the new Prime Minister, Shinzo Abe, is supportive of nuclear energy and advocates the restart of select nuclear reactors, starting with the most modern reactors that are farthest from fault lines. Seven Japanese utility companies have applied for inspections by Nuclear Regulation Authority, and about ten reactor restarts are expected during 2014, though contentious public demonstrations may delay the restarts.

Most importantly, China continues to move forward in the commissioning of new reactors under in its Five Year Plan, which encompasses 2011 to 2015. In October 2012, China’s State Council resumed that nation’s nuclear program under sweeping new operating safety standards. According to the World Nuclear Association, China has 29 new reactors under construction, 57 being planned and 118 being proposed; in the next two years, China is expected to approve another four to six reactors.

European nations have limited options concerning the production of electrical power. The United Kingdom is moving forward to construct a new third nuclear power station (Hinkley Point C) at Hinkley Point while France is constructing a reactor at Flamanville. Slovakia is in the process of constructing two units, Russia ten, Finland one and Belarus one. However, Germany is in the process of shutting down its remaining nine nuclear power units. After the Fukushima crisis, Chancellor Angela Merkel formed a review panel in response to anti-nuclear protests across Germany. Reversing the government’s extension plan, Environment Minister Norbert Rottgen announced in May 2011 that all the Germany's nuclear power plants would be decommissioned by 2022.

On the supply side, the Highly Enriched Uranium (HEU) agreement ended last year, removing approximately 24 million pounds (10,900 tonnes) of uranium from the market annually, a significant amount since the global annual amount of uranium required to fuel currently operating reactors is 65,908 tonnes (which is equivalent to 77,725 tonnes of  U3O8). Signed in 1993 by Russia and the United States, the HEU agreement created the Megatons to Megawatts Program under which Russia agreed downblend 500 metric tons of high-enriched, weapons-grade uranium from roughly 20,000 Soviet-era nuclear warheads to low-enriched uranium fuel that would be purchased for use at U.S. nuclear power plant reactors. For the last five years, HEU supplied about 45% of U.S. demand (or 13% of the world’s needs) with approximately 24 million pounds of uranium annually. The last shipment was completed in December 2013.

In the last couple of years, due to the low uranium prices, there have been numerous deferrals of both new projects and expansions of existing mines, along with outright cancellations of previously planned mines. In October 2012, BHP Billiton (BHP) postponed indefinitely its planned expansion for its Olympic Dam project in South Australia. In February 2013, Cameco (CCJ) wrote-down its Kintyre mine project in Western Australia by $162.5 million and decided not to proceed with a feasibility study. The high-cost mine’s breakeven point was estimated to be $67 per pound. In November 2013, Uranium One, a wholly-owned subsidiary of Russia’s state-owned uranium company Atomredmetzoloto, suspended production at its ISR Honeymoon project in South Australia. In December 2013, AREVA SA (the French nuclear company) announced that the start of production at the prospective Imouraren uranium mine in Niger was being delayed until the end of 2015.  In February 2014, Paladin Energy announced the suspension of production from its Kayelekera uranium mine in Malawi, removing its annual production capacity of 3.3 million pounds of U3O8 from the market. The high-cost mine has been placed on care and maintenance status until the price of uranium can justify profitable operation. As a sidelight, Rio Tinto Plc (RIO) was required to suspension production at Ranger uranium mine in the Northern Territory of Australia and the Rössing processing facility in central Namibia due to leaching tank failures at both facilities. The operational problems put the annual production of the two mines (11.8 million pounds of U3O8 or roughly 15% of global uranium requirements) in jeopardy. Rössing restarted during the first quarter of 2014, but Ranger remains closed awaiting regulatory approvals.

The Republic of Kazakhstan produced 22,500 tonnes (49.6 million pounds or 38% of global production) of uranium in 2013. With almost all of Kazakhstan's 17 mines employing In Situ Leach (ISL) operations, the cash cost of production is low, varying between $11 and $28 per pound of U3O8. Though production capacity is estimated to be around 25,000 tonnes of uranium per year, Vladimir Shkolnik (the Chairman of Kazatomprom, the national operator of the Republic of Kazakhstan) has recently reaffirmed the delay of both new uranium projects and expansion of existing mines in light of low uranium prices. Incidentally, snow melt disrupted some of the ISL uranium operations in southern Kazakhstan during March 2014, which hampered production.

However, adding complexity to the supply-demand analysis, unknown quantities of inventory (secondary supply) overhang the market. The U.S. Department of Energy has the authority to sell excess supply of its uranium stockpiles under the Excess Uranium Inventory Management Plan. Though the remaining excess inventory totals 108.3 million pounds of U3O8, the amount sold in a given year has been limited to roughly 5 million pounds (2,270 tonnes) in the past. Also, Japan has a stockpile of approximately 100 million pounds (45,400 tonnes) of U3O8, which was acquired through adhering to the terms of long-term contract commitments.

Combining the supply and demand situations, the uranium market is setting up for a significant imbalance in the next few years. Since stocks tend to discount the anticipated future, investors should be closely monitoring the uranium space to take advantage of this opportunity.

With the reaffirmation of China’s nuclear power program, the anticipated restart of two Japanese reactors and the end of the Megatons-to-Megawatts program, uranium stocks are exhibiting the signs of a potential rally. Though the specific catalyst that will inaugurate the renaissance is difficult to determine a priori, it should be noted that the uranium sector rallied 9% in late February on the announcement of the draft of Japan’s Basic Energy Plan, which confirms that nation remains committed to nuclear power. Also, a recent wildcard is that Vladimir Putin's aggressive implementation of Realpolitik in the Ukraine may pressure European nations to eschew the use of imported natural gas from Russia, which may lead to a greater reliance on nuclear power. With over 160 nuclear reactors, Europe is the largest per capita user of nuclear power, with France, Slovakia, Belgium, Hungary, the Ukraine and Sweden highly dependent on electricity generated from nuclear plants.

Beneficiaries

The uranium industry is composed of many companies from major established producers to more speculative junior exploration companies. Though larger producers tend to have greater resources to navigate periods of depressed market conditions, smaller companies provide greater leverage to the anticipate rise in uranium prices.

The majority of uranium is supplied to power plants through long-term contracts which are priced at a premium to spot market. Though currently these long-term contracts allow certain uranium producers to continue selling some of their uranium production profitably, the uranium producers with lower proportions of contract sales will benefit to a greater extent from the anticipated rise in uranium prices. In addition, spot prices are more volatile than long-term contract prices, which will contribute to leveraged stock price movements of producers that sell predominately on the spot market.

The primary beneficiaries of the anticipated recovery driven by the expected upcoming fundamental supply deficit ought to be low-cost producers of uranium with the financial wherewithal to weather the current period of depressed uranium prices.

Uranium Energy Corp

With offices in Corpus Christi Texas and Vancouver British Columbia, Uranium Energy Corp. (UEC) is a low-cost ISR producer of uranium concentrates and an acquirer and developer of uranium projects. The company’s impressive portfolio of uranium properties, which are in various stages of development, are located in south Texas, Colorado, Arizona, Wyoming and the Republic of Paraguay.

The company has six uranium projects in South Texas: Palangana, Goliad, Burke Hollow, Salvo, Channen and Anderson;

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seven properties in Colorado: Slick Rock, Bull Canyon, Raven, Long Park, Radium Mountain, Carnotite and Paradox; five properties in Arizona: Anderson, Workman Creek, Artillery Peak, New River and Dry Mountain; four properties in Wyoming: Burnt Wagon, DL Prospect, East Poison Spider and LO-Herma and two projects in the Republic of Paraguay: Yuty and Oviedo.

NI 43-101-compliant resource estimates have been completed on eight of the company’s properties:

Palangana ISR Project in Duval County, Texas (a Measured and Indicated reserve estimate of 1.06 million pounds U3O8 grading 0.135% [of which 0.49 million pounds have been mined] and an Inferred resource of 1.06 million pounds U3O8 grading 0.135%)

Goliad ISR Project in Goliad County, Texas (a Measured and Indicated resource estimate of 5.47 million pounds U3O8 grading 0.05% and an Inferred resource of 1.5 million pounds U3O8 grading 0.05%, both at a cut-off of 0.03%)

Burke Hollow ISR Project in Bee County, Texas (an Inferred resource estimate of 2.89 million pounds U3O8 grading 0.05% at a cut-off of 0.02%)

Salvo Project in Bee County, Texas (an Inferred resource estimate of 2.8 million pounds U3O8 grading 0.091% at a cut-off of 0.02%)

Nichols Project in Karnes County, Texas (an Inferred resource estimate of 1.3 million pounds U3O8 grading 0.07% at a cut-off of 0.3%)

Slick Rock Project in San Miguel County, Colorado (an Inferred resource estimate of 11.6 million pounds U3O8 grading 0.228% at a cut-off of 0.15%)

Anderson Project located in Yavapai County, Arizona (an Indicated resource estimate of 15.5 million pounds U3O8 grading 0.028% and an Inferred resource estimate of 2.5 million pounds U3O8 grading 0.024%, both at a cut-off of 0.01%)

Workman Creek Project in Gila County, Arizona (an Inferred resource of 5.54 million pounds U3O8 grading 0.086% at a cut-off of 0.05%)

Uranium Energy also has exclusive ownership of the Tronox Worldwide, Jebsen, Brenniman, Halterman Kirkwood and Moore databases, which contain maps, log data, exploratory drilling results and other documents and reports. The company controls one of the largest historical uranium exploration and development databases in the US. Through the use of these databases, Uranium Energy has been prudently acquiring uranium properties in the southwestern US.

Management’s business strategy in south Texas entails expanding the company’s hub-and spoke system whereby six satellite In-Situ Recovery mining projects operations within the South Texas Uranium Belt are expected to feed supply to the company’s 100% owned Hobson processing facility.  The fully-licensed processing plant has an annual capacity of 2,000,000 pounds of uranium concentrate (yellowcake).

Uranium Energy began extracting uranium through In Situ Recovery (ISR) operations in November 2010 and sold its first batch of uranium concentrate (60,000 pounds of U3O8 at $52 per pound) in October 2011. Since acquiring the Palangana property and Hobson ISR processing plant in December 2009, management was able to achieve production in relatively short order. This is a testament both to management and to the Texas regulatory authorities, which have developed and employed a unique streamlined permitting framework for the advancement of uranium mines.

During fiscal 2012 and 2013, Uranium Energy sold a total of 490,000 pounds of U3O8 for $22,783,725. Though the company entered into a sales contract, the price is based on the spot price at the time of delivery; therefore, UEC’s production is 100% un-hedged.

While extracting uranium from the Palangana mine and processing the ISR uranium-loaded resin beads at the Hobson processing facility, management continued expanding the company’s resource base with acquisitions and developing its properties through exploration and pre-extraction activities. During fiscal 2013, final uranium extraction authorization was received for the Goliad project from the Texas Commission on Environmental Quality; in addition, drilling programs were completed at the Burke Hollow and Channen projects in Texas.

In early September 2013, management reprioritized production targets and capital expenditures to optimize the long-term capabilities of the company. Operations at the Palangana mine were reduced in order to preserve the company’s reserves until the anticipated improvement in uranium prices enables greater value to be attained from the company’s resources. The company has not reported any sales from uranium yellowcake in the two subsequent quarters. Select pre-extraction, permitting and exploration expenditures are expected to continue, especially at the Goliad and Burke Hollow projects, thereby positioning Uranium Energy to be able to upscale its operations with permitted and extraction-ready projects when the price of uranium strengthens. Management has intentionally curtailed production from Palangana in order to preserve reserves so that the company can better benefit from the anticipated upswing in uranium prices at a later date.

Uranium Energy appears to be able to continue financing its operations. In October last year, the company sold 3,380,954 Units at $2.10 per Unit providing $6.63 million in net proceeds to advance its projects in south Texas. Also, in March 2014, Uranium Energy took further advantage of its $20,000,000 senior secured credit facility, which was extended by deferring required principal payments by two years to July 31, 2016 and extending the credit facility. The modification to the credit facility demonstrates the commitment of the two lenders: Sprott Resource Lending Partnership (a subsidiary of Sprott Inc.) and CEF Capital Markets. These transactions will help fund the company’s projects in Texas, along with providing the company with financial flexibility to navigate this period of depressed U3O8 prices.

Though Uranium Energy has the usual risks associated with all junior miners, in our view, the ultimate risk is the amount of time the price of uranium remains depressed. Management is attempting to preserve the value of the company’s resources until the long-term fundamentals bring about the anticipated renaissance of the uranium industry. When price of uranium recovers, management intends to ramp-up production.

Since Uranium Energy operates as an un-hedged, lower-cost ISR uranium producer, the company’s stock is levered to the price of uranium. When the challenging uranium market conditions abate, Uranium Energy is positioned to provide a leveraged opportunity to participate in the upswing in uranium prices.



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