On July 6, 2015 I released the first part of this article that made the case that the long-term fundamentals underpinning the uranium market are very bullish, but at this point in time the uranium market is still in the grasp of a bear market.
In review, despite the nightmarish Japanese Fukushima nuclear disaster of 2011, most nuclear power generating countries are STILL committed to nuclear power, and today there are more reactors under construction than before the disaster.
In spite of the radiation horror unleashed by the massive Japanese earthquake, Tsunami and the tremendous fear its generated among the public around the world — nuclear power remains the cleanest and most inexpensive source of electricity. Given the economics of nuclear generation and the reality that electricity is one of the main determinants of a country’s standard of living. In fact, reliable electricity is one of the universally proven ways to lift people out of poverty.
After the Fukushima disaster, Japan decided to shut down all their remaining reactors. However, as a result the cost of energy has been soaring because Japan has been forced to import larger amounts of fossil fuels.
Then in 2012 a pro-nuclear government was voted into office in Japan and they have and continue to work on restarting all of the country’s idled 48 nuclear reactors. While Japan’s pro-nuclear energy forces have been making headway, it hasn’t been a cake work.
Strong opposition from the Japanese population still is evident given the steady and large protests that still take place around the country frequently.
So even though the numbers of people in favor of nuclear energy are larger than the number of opponents in Japan, the future for uranium is still uncertain in Japan, but the government continues to plan for about 20% of the country’s electric generation will come from domestic nuclear power plants by 2030.
Germany is another country that received a lot of press when they announced that they planned to completely eliminate their dependence on nuclear power, and instead has banked on an “renewable energy revolution” where the majority of electricity will come from solar, wind, and hydrogen by mid-century.
German confidence in developing renewable energy generation, government planners have announced the intention to close down all the country’s nuclear reactors by 2022. However, as with Japan, the cost of electricity has risen substantially in Germany as a result of its recent efforts to move away from nuclear power.
In fact, the economics of nuclear electric generation, Germany is actually “cheating” by importing nuclear-generated electricity from France. Some argue that the renewable energy generation will not be cost effective enough to be relied on for 10 even 20 years. While the argument of nuclear energy rages in Germany, the country remains committed to eliminating nuclear energy generation and relying on emerging renewable energy alternatives. Only time will reveal if German aversion to nuclear energy will last.
Current Supply Demand Picture for Uranium
Despite demand being higher than primary supply, uranium prices are depressed due to a short/medium-term supply glut from secondary stockpiles. Prices might stay low for the foreseeable future, especially now that oil and gas prices have tumbled, making fossil fuel-generated electricity less expensive.
But the stockpiles are slowly dwindling, and in the longer term uranium prices should go up. In a world of rising demand and dwindling supply, UPC’s stockpiles should become valuable because utilities that need to cover their short-term uranium demand can purchase it from the company.
The International Energy Agency has estimated that nuclear energy will grow 66% from 2011 to 2035. However, uranium supply is not readily available because the current price is too low for it to be economical to open new mines. When increasing demand eventually catches up with decreasing supply, prices should go up.
Taking advantage of the depressed environment in the Uranium market to start taking positions in companies that will see dramatic gains – as the nuclear paranoia subsides.
Uranium Participation Corp (U.TO) which we will refer to as UPC was founded in 2005 and is listed on the Toronto Stock Exchange. It trades under the ticker “U” and currently has a market cap of around $CAD 600 million.
The business of the company is to buy and hold uranium in the form of U3O8 and UF6. The primary objective of the company is to achieve appreciation in the value of its uranium holdings and the company invests at least 85% of its funds in uranium. Uranium is not a freely traded commodity and UPC is therefore a vehicle that enables investors to invest in the commodity directly. Some analysts have likened UPC to an exchange traded fund, however the company has pointed out that they are a publicly traded corporation, not an ETF.
UPC does not actively speculate on the price of uranium and it does not enter into long-term contracts, nor does it trade its inventory. Due to the nature of the company the risks associated with UPC are lower than for other uranium companies. The benefit of UPC is that it does not mine uranium so there is no project risk or operating risk.
The strategic decisions of the company are made by the directors, but the daily running of the company is outsourced to Denison Mines Inc., which takes directions from the board. The management is paid an annual fee of $CAD 400,000+0.3% of net asset value (NAV) in excess of $CAD 100. At fiscal yearend 2015 (February 2015), the NAV was around $CAD 730 million. Management also receives a fee if the company purchases uranium, which is 1.5% of the purchase amount.
Investors who believe in the uranium renaissance, but who think it’s too risky to buy uranium producers, might find that UPC is a good option. Below I lay out the details of the company and the aspects that potential investors need to be aware of.
Uranium Participation Corp’s Directors
Below I have laid out short bios on the directors and the management to give readers a sense of their background and their capabilities to run the company.
The Directors: The board of UPC makes the strategic decisions of the company, but the actual managing of the company is outsourced to Denison Mines Inc. (which is owned by uranium producer Denison Mines Corp.). Denison does not own any part of UPC and the two companies do not have any directors in common.
Paul Bennett is one of the directors and has been with the company since it was founded in 2005. In addition to his decade’s experience with UPC, Bennett has over 40 years’ experience in the natural resources industry and has a bachelor’s and master’s degree in geology.
Thomas Hayslett has been a director for little over a year and has 35 years of experience in the uranium industry. He has held several positions within the industry and was Senior Consultant at The Ux Consulting Company, which is one of the uranium industry’s leading consulting companies. He has a bachelor’s and a master’s in nuclear engineering.
Jeff Kennedy has been a director at UPC since 2005 and has experience from the finance industry. He is currently CFO and a Director at Cormark Securities, an investment dealer focused on Canadian companies.
Garth MacRae has been a director since 2005 and has also served as a director of Dundee Corporation since 1991. Dundee is a Canadian company with operations within investment advisory, corporate finance, energy, resources, agriculture, real estate and infrastructure. MacRae also holds directorships in several other companies.
Richard McCoy has been a director since 2005 and is the Chairman of the Board. He was previously Vice Chairman of TD Securities, the Canadian investment bank. He also serves as a director for several other companies.
Ganpat Mani recently joined the board of UPC. He retired from his position as CEO and President of ConverDyn in 2013. ConverDyn provides UF6 conversion to utilities that operate power plants in North America, Europe and Asia. Mani also has previous experience with Australian uranium producer Paladin, and currently also sits on the board of Uranium Energy Corp. He also served as a director of the Nuclear Energy Institute and was a member of the U.S. Civil Nuclear Trade Advisory Committee.
UPC’s Experienced and Competent Management
The management of UPC is made up of three key people, Ron Hochstein (President and CEO), James Anderson (CFO), Scott Melbye (Vice President, Commercial) and Sheila Colman (Corporate Secretary).
Ron Hochstein is a professional engineer and he is also Executive Chairman of Denison Mines Corp., which owns Denison Mines Inc., the company that manages UPC. Before Denison he was President and CEO of International Uranium Corporation.
James Anderson, is the CFO of UPC and he is currently a consultant to Denison Mines Inc. (the Manager). He previously served as CFO for Denison Mines Inc., but he stepped down in 2012.
Scott Melbye recently joined UPC and he has 31 years of experience in the uranium industry. He is also Executive Vice President of Uranium Energy Corp. He also spent 22 years at Cameco, one of the biggest uranium producers in the world, and had a stint at Uranium One. He has also held several other relevant positions within the uranium industry.
Evaluation of the directors and managers
Based on the bios above it is clear that the directors and managers of UPC have extensive experience in the industry. With several of them having decades of experience with uranium I believe shareholders can trust the directors and managers to be good stewards for the company.
UPC’s strategy is to achieve appreciation in the value of its uranium. This value is reported as Net Asset Value (NAV) and is calculated every month. The NAV figure is calculated by deducting the company’s liabilities from its assets. At the end of the calendar year 2015 (February 28th 2015) the NAV figure was around $CAD 730 million. That was an increase from about $CAD 602 million at the end of fiscal year 2015.
Historically the company has traded at both premiums and discounts to the net asset value. During good times it has tended to trade at a premium, while during bad times (e.g. after the Fukushima incident) it has traded at a discount. This is represented in the chart below. Investors who are interested in buying UPC should first determine if the company is trading at a discount or premium to the NAV before investing.
Premium/discount to NAV Char
If the discrepancy between the share price and NAV is very large, the board can choose to buy back shares (if the stock is trading at a discount to NAV) or issue new shares (if the stock is trading at a premium to NAV).
Since its incorporation in 2005 the company has made nine public offerings with aggregate proceeds of $704.6 million. The last public offering the company had closed in February 2014. They used the proceeds to buy uranium at an average price of $USD 35.07 per pound, which is a good price. The average cost per pound of U3O8 for the company is now $USD 38.75 and the price for UF6 is $USD 105.41. These average prices are low when put in an historical perspective, which shows that management is adept at buying at depressed prices. However, their timing has not always been perfect as they bought uranium in 2007 at $USD130, which was almost as close to the top as possible.
As of February 2015 the company had 9.3m pounds of U3O8 and 2m KgU of UF6. The uranium is stored with reputable third parties in the US, Canada and France. In 2014 the company’s storage fees totaled $2.4 million and the management fee totaled $1.9 million.
The company also entered into an agreement to loan out 1.3 million pounds of uranium for two years. This will provide the company with revenues to cover future operational costs.
Net Income: UPC’s corporate strategy is different from other uranium companies. It does not produce and sell uranium and the profits are derived from an increase in the value of the uranium that the company holds. Consequently, UPC does not present a profit and loss statement in its annual report for the fiscal year ended February 2015. It does, however, present the balance sheet and cash flow statement.
Due to the absence of a profit and loss statement we cannot evaluate UPC as we would another company. The profit and loss for any year comes from the unrealized appreciation or depreciation in the value of its uranium holdings (assuming that they did not sell any of their holdings). Due to the fluctuations in the uranium price over the last decade, the net income has in turn fluctuated considerably (chart below).
As a result, looking at the company’s P/E ratio does not make much sense because earnings are derived from the movement of the price of uranium, not from the operations of the business. Additionally, looking at measures such as net profit margin and return on equity does not give us much information either.
However, even if the company does not have normal operations, they still report unrealized profits/losses and these must be taxed. Up to this point the taxes have fluctuated due to fluctuation in net income over the years.
Over the last 10 years the income tax per year has averaged out to $CAD 1.1 million, which is a low figure compared to the company’s net asset value. In fiscal year 2014 and 2015 the tax was nil. However, one important thing that investors must be aware of is that as the price of uranium starts to increase, the company will have to pay income taxes on its unrealized profit. Subsequently if investors sell their shares, they are taxed a second time when they pay capital gains taxes. The result is that investors will have to pay double taxation for holding a commodity. So although UPC can be compared to an ETF, at the end of the day they are not. They are a corporation, and must therefore pay income taxes.
Balance Sheet and Cash Flow
As I pointed out above, UPC differs from other companies due to its operating nature. But since the company is a corporation, it’s important for investors to understand its balance sheet and cash flow.
In 2015 the balance sheet was effectively made up of cash and uranium on the left hand side, and mainly equity on the right hand side of the balance sheet. The assets summed up to $CAD 733 million, while the equity summed up to $CAD 731 million. The difference of $CAD 2 million comes from payables to Denison for managing the company. The equity of $CAD 731 is the net asset value of the company, i.e. the value to the shareholders.
From 2014 to 2015, cash reduced from around $CAD 65 million to $CAD 17 million. This is a result of the company purchasing uranium for a cash consideration of about $CAD 42 million, so the reduction in cash is not a cause for concern. It’s actually a good sign because the company bought more uranium at low prices.
The other notable changes in the balance sheet from 2014 to 2015 are the line items “investments in uranium” and “total equity”. Investments in uranium increased from about $CAD 540 to $CAD 715 because the company purchased CAD 42 million worth of more uranium, while at the same time the price of uranium increased over the year. Total equity increased from around $CAD 602 million to $CAD 731 million, which was a result of a $CAD 129 unrealized profit for the year.
Cash flow from operations has been somewhat negative each year. Unrealized gains or losses from the uranium holdings are non-cash items so they are added back in the cash flow statement, which is also the case with deferred income taxes.
Since the company does not present a profit and loss statement, it’s somewhat difficult to glean how the cash flows from operations are made up. The unrealized gain/loss for the company’s uranium holdings for the year is added back to the net profit figure for the year, however there is a slight discrepancy between the numbers, which leads to the slightly negative net operating cash flow each year.
I believe it is safe to assume that these cash outflows are related to the operations of the business, mainly management fees paid to Denison, as well as storage fees for the uranium. These cash outlays are small compared to the value of the company. The cash outflow in 2015 was $CAD 6 million, which compares to a net asset value of around $CAD 731 million in February 2015.
Cash Flow From Investing is mainly affected by the company purchasing uranium. In 2015, net cash from investing activities was $CAD 41 million (cash outflow). That was made up of $CAD 42 million used to purchase uranium, minus $CAD 1 million for the “sale of conversion components, net of cost”. This last item simply means that the company sold some of its UF6 in exchange for U3O8 and cash. In 2014, the company did not buy any uranium and the only cash inflow they had from investments was cash that they received from the conversion of UF6 to U3O8. This amount totaled about $CAD 2 million.
Cash Flow From Financing activities is mainly affected by issuance of new shares and the repurchase of old shares. The only cash outflow from financing activities in 2015 was a cost of $CAD 82,000 related to the share issuance that took place the year before.
Although UPC is inherently less risky than other uranium companies, there is still risk related to investing in the company.
The most apparent risk is naturally the price of uranium. The long-term prospects for the industry are favorable, however, there are factors that may jeopardize the outcome. Firstly, the situation in Japan is tentative and nobody knows for sure what the outcome will be. Secondly, renewable energy might start to play a bigger part of the energy mix in the years to come, exemplified by Germany’s efforts to switch over to renewables. Lastly, weaker oil and gas prices put pressure on uranium prices because electricity from these alternative sources becomes less expensive.
Another risk is that the companies that UPC stores their uranium with can go bankrupt. This happened in 2013 when a company (USEC) that stored $CAD 142 million worth of UPC’s uranium, announced that it would cease uranium enrichment at one of its plants. As a result UPC decreased the fair value of it’s uranium by $CAD 4 million due to the risk associated with holding uranium at the plant. UPC plans to move its uranium over the next 18 months and the cost is expected to be offset by the fair value adjustment of $CAD 4 million.
UPC is essentially a pure play on the price of uranium and is a good vehicle to get exposure to the commodity. The company essentially buys uranium and holds it, with the aim that it will increase in price. The risk profile is lower than other uranium companies because UPC does not have any project risk or operating risk. Moreover, the directors and management of UPC are very knowledgeable and they have long experience within the uranium industry.
UPC can be a good investment for more risk averse investors who want to play the uranium market. And now might be a good time to buy as the share price is back at levels seen in 2005. The uranium market will probably not turn for a while, but investors with a contrarian inclination and patience might want to consider buying shares of UPC on dips back to its 52 week low of $4.81. That’s about 10% from current levels.
(Contributions from Lars Haug)