Cameco is a “Buy”

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There is only one uranium blue chip, and that’s Cameco Corp. (NYSE:CCJ), based in Saskatchewan, Canada. It is the second largest uranium miner in the world, after Kazatomprom. Cameco produced about 20 million pounds last year, or 16% of the world’s supply. It aims to double production by 2018 from its existing assets – nearly a billion pounds of resource – excluding potential acquisitions.

Cameco’s world-class assets have among the lowest costs in the industry. Ore grades at its McArthur River mine, for instance, are 100 times the world average. That means it can produce more than 18 million pounds per year by mining only 150-200 tonnes of ore per day.

Cameco’s MacArthur mine is the world’s highest-grade mine – and it isn’t even a close contest. Take a look at the next chart, from Forest’s piece:

Ore Grades for Uranium Mines

As Forest comments: “Top producer McArthur River grades a towering 17.7%. After this, the world’s other top mines barely show up! McArthur is 2,360% richer than number two Rabbit Lake. And a staggering 59,000% higher than the number ten mine, Rossing.”

Rabbit Lake, by the way, is also a Cameco mine. Again, other mining sectors show a smoother curve as you move from left to right. But uranium is quirky.

It’s also involved in all facets of nuclear power, not just mining. It owns uranium-processing plants and power generators and invests in new enrichment technologies. It also trades uranium, buying it from third parties and reselling it for a profit. These non-mining interests produce about half of Cameco’s sales.

You can see the merit of this setup in the chart below. Cameco was the only uranium company to earn a double-digit, much less a positive, return on equity last year. Not bad. As the old money manager Martin Sosnoff once wrote, “If you can run a hotel at 102% occupancy during a recession, how bad can it get when business is better?” The same thinking applies to Cameco.

Cameco Growth

So why now? What specifically makes Cameco a good buy now?

First, there are lingering clouds over Cameco that make its stock cheap. Among one of the biggest such clouds is its largest new project, Cigar Lake. It flooded in 2006 and again in 2008, halting development. Cigar Lake was to add 9 million pounds of uranium production a year! It is a world-class deposit, one of the best in the world. Yet there is a lot of uncertainty over this mine, which helps tamp down the stock price.

Recently, Cameco finally pumped all the water out and sees production in 2013. This is potentially a big catalyst for Cameco’s stock as more good news unfolds about Cigar Lake through the year. All the bad news is baked in the price already. And remember, starting new mines is a universal difficulty in this industry, as we’ve seen above. That’s part of the appeal of uranium – it’s not like you can wander out on some moose pasture and start putting it in bags to take home.

Secondly, Cameco recently released lowered guidance for 2010. Wall Street was disappointed in its near-term growth outlook. Classic short- term thinking, as nothing has changed longer term for Cameco. If anything, the outlook is better now, which brings me to item No. 3.

Cameco recently sold its stake in Centerra Gold, which netted Cameco $871 million. Cameco sold it right near the top of the market for gold. But the main thing is that the company now has a war chest of $1.3 billion against debt of only $1 billion. It has great financial strength and the flexibility to make acquisitions and do other potentially good things. I liked the sale, and I look forward to seeing how Cameco puts the money to work in uranium.

Cameco is also well insulated should uranium prices remain soft. That’s because Cameco sells a lot of uranium through long-term contracts. Many of these contracts are old and at prices lower than today’s. So as these contracts roll off, Cameco’s earnings will rise even if uranium goes nowhere.

The trade-off is that Cameco doesn’t enjoy as much an immediate windfall if uranium prices spike as a smaller more speculative miner that sells everything on the spot market. But I’ll take the safety.

This reminds me of the wise words of Sherlock Feldman, casino manger at the Dunes for many years when it was one of the largest gambling clubs in Las Vegas. Feldman saw a lot of people lose a lot of money to greed. A life so spent must make one philosophical about the nature of greed. He once said of gamblers, “If they wanted less, they’d go home with more.” The same is true of investors.

The net asset value (NAV) of Cameco is around $25 per share. The stock price is less than $25 currently. Furthermore, that NAV is depressed because current uranium prices are so low. I’m comfortable having $25 of depressed NAV to cover my downside. When uranium prices go up, so will Cameco’s NAV. Every $1 increase in uranium prices adds nearly a $1 to Cameco’s NAV. Plus, Cameco often trades at multiples of 1.5 times NAV and higher. This will provide good upside when uranium prices start running again. Keep in mind that in 2007, investors shelled out nearly $60 per share to own Cameco – more than double today’s price.

Still, the bottom line: Cameco is a speculation on a higher uranium price. If uranium goes nowhere, Cameco will not be an exciting investment, though we shouldn’t lose money at these prices.

Cameco has no net debt and a boatload of cash. In 2010, it should generate around $900 million in cash flows. It is the Superman of the uranium world. No worries here. Cameco also fits with our preference for owning tangible assets – the classic, durable means of wealth creation and preservation. Uranium ought to prove a wonderful inflation hedge if our thesis plays out. This is one to buy and sock away for a few years.

Grandey summed up the appeal of his company in his closing remarks of Cameco’s last conference call: “With both an enviable balance sheet and an extraordinary reserve and resource base to build upon, Cameco has a number of pathways to reach our goal of doubling production. You can rest assured that the pathways we pick will be the ones that will add the best long-term value to Cameco.”

Cameco’s exceptional properties and long-term prospects reside within a very bullish long-term outlook for uranium. The bull case for uranium is right here in this chart:

Uranium Mine Cost Production

On the vertical axis are uranium supply costs and on the horizontal axis is demand. The low-cost mines are in the $10-15 a pound range and all in Saskatchewan. Olympic Dam is highlighted because it is the exception. It is a BHP mine in Australia that produces copper and gold as well. These other metals lower the cost of extracting uranium, but it is not a pure uranium mine.

As demand moves higher, you can see how the cost rapidly shoots up. In fact, the World Nuclear Association says that 2010 demand will come at 81,000 pounds. That puts us against the right-hand part of the curve.

It’s true that some uranium will come from existing stockpiles and recycled uranium. But the stockpiles are dwindling and recycled uranium is still a tiny piece of the pie. All is to say that the pressure on the uranium price will be high. It must move higher to induce these marginal mines to produce.

In that world, Cameco stands tall. The stock is trading for only 9 times next year’s cash flow per share guess of $2.59, which is likely too low. It also trades just under my $25 estimate of net asset value per share. Plus, we own a super strong balance sheet with no net debt and over $1 billion in cash.

Cameco is a buy.

Chris Mayer
for The Daily Reckoning Australia

Chris Mayer
Chris Mayer is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Mr. Mayer's essays have appeared in a wide variety of publications, from the Mises.org Daily Article series to here in The Daily Reckoning. He is the editor of Mayer's Special Situations and Capital and Crisis - formerly the Fleet Street Letter.
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