Buying Cameco

5 Aug 2010 by Jim Fickett.

Cameco is a large uranium miner, reactor fuel fabricator, and electric utility. It owns excellent low-cost deposits and has healthy cashflow. Cameco is reinvesting much of its earnings to successfully grow the business. Unlike most of the market, it is not overpriced.

On Wednesday I bought shares of Cameco, a large uranium miner, for 2% of the portfolio. This is partly a continuation of the uranium theme, but Cameco is quite a different investment from uranium itself. Cameco is 2/3 a uranium miner, and 1/3 a utility providing fuel fabrication and electric power. Further, it delivers most of the uranium it mines by long-term contracts that smooth out the volatility in the uranium price.

I think of Cameco as a Warren Buffet type of company, that is, a well-managed company, with a long history of making a solid product, in an area with a high barrier to entry, and with growing returns that are all but guaranteed for a long time.

Cameco is reasonably priced. Financial assets and debt net to roughly zero, so the value of the company is in know-how, uranium reserves and resources, and the revenue stream of the utility activities.

The uranium mining business is about 2/3 of the company (by revenue). 2/3 of the market capitalization is about $6.8 billion. Uranium reserves plus resources come to about 970 million pounds of U3O8. So the market values the uranium in the ground at about $7/lb. In 2009 the average difference between cost of production and realized sales price was about $12/lb.

On the utility side, earnings before taxes on electric power generation were $224 million in 2009, and gross profit on fuel services was $50 million. So the P/E for the utility portion of the company is about $3.4 billion / $274 million, or 12.4.

Seeing that nuclear energy is growing extensively now, Cameco is greatly expanding mining operations, with the goal of doubling production by 2018.

Cameco has as least a 50% stake in two of the largest and highest quality deposits in the world – McArthur River and Cigar Lake. As mentioned before, this allows them to meet 16% of world demand at low cost, giving them impressive returns. This situation will continue for a long time. Cigar Lake will start producing in 2013 and probably wind up in 2028. At McArthur River, just proven reserves would last 18 years at current production rates, and there is probably at least 50% more in resources.

Rather than distribute these profits now, Cameco aims to grow the mining business. Spending on exploration and development has grown from $11 million in 2002 to an estimated $95 million in 2010. Exploration and development to date has been successful, with reserves, resources, and production all growing. They are beginning production in another of the world's lowest cost areas, Kazakhstan, in collaboration with the Kazakh national uranium company, Kazatomprom. They also have producing mines in the US, development underway in Australia, and ongoing exploration in Latin America. It is always hard to tell about such things, but I think there is a good chance they will succeed in their goal of doubling production.

That means, assuming uranium price rises at least keep up with increases in their costs, that their earnings will grow substantially.

I have written a great deal already about uranium prices, so I won't deal with any risks in that direction. And exploration risks have already been mentioned.

Probably most people would view the difficulties at Cigar Lake, mentioned in the recent post on uranium prices, as the primary risk. This is a very large deposit, thought still to be low-cost, and any failure to bring it into production at approximately the planned cost would weigh heavily on profits. It would take very specialized expertise to evaluate the details of their plans. But I would just point out that similar problems (weak, collapsing sandstone and flooding) have been faced at McArthur River, and some of the techniques planned at Cigar Lake (freezing the sandstone to stabilize it and prevent flooding, remote-control mining) have already been successfully applied.

It is political risk in developing countries that I find hardest to evaluate. Hundreds of millions have been invested in Kazakhstan. This is not a part of the world that leaves me feeling entirely comfortable. However I do agree with the strategy of working there, in a joint venture with Kazatomprom. Kazakhstan has the second highest level of identified uranium resources of any country in the world, and these resources are low cost.

This brings my uranium-related investments to 5% of the portfolio, which is rather a large position for me. My motivation is (1) I think we will see gradually increasing energy prices for a long time, and (2) I think both uranium and Cameco are reasonably priced, unlike many energy commodities and companies. But 5% is enough and I'll be looking at other areas now.

Note: almost all information in this article is from quarterly and annual reports on the Cameco website. Although I also read some analyst reports, and some popular articles, I did not find any particularly helpful commentary.