By Chris Berry (@cberry1)
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The last constructive note I wrote on the uranium space occurred in March of 2014. My thesis was simple: a glut of excess capacity on world markets coupled with financing challenges for juniors and developers portrayed a sector that, despite the long-term positives, was set to underperform other commodities or indices.
It was time to take profits.
My timing couldn’t have been better with an equal-weighted basket of uranium names I’m tracking falling by almost 38% last year (this doesn’t take into account currency conversions, either, which likely would have hurt returns even more). Until one of several catalysts came into being including the oft-delayed re-start of some Japanese reactors or significantly higher uranium prices, uranium plays were likely best left on a watch list. It was also interesting to note that while the spot price of uranium rose to over $40 per pound in 2014 and a host of geopolitical issues with Russia rose to the fore, the froth didn’t transfer over to uranium equity price appreciation regardless of the market cap.
That said, I believed then and still do now, that a focus on low-cost near-term production stories offered the best way to “play” the uranium sector. While mineral exploration is a totally rational and necessary expense, “discovery holes” aren’t giving investors the returns they’ve become accustomed to in the current market environment and uranium is no exception. My thesis maintained that share price appreciation would come from one of two areas: the aforementioned low-cost near-term production stories or M&A.
The recent proposed take out of Uranerz (URZ:NYSEMKT, URZ:TSX) by Energy Fuels (UUUU:NYSEMKT, EFR:TSX) appears to have validated this thesis and this could be the spark to commence additional consolidation in uranium as low prices (rendering most uranium development uneconomic) appear set to remain in place.
I have written and spoken publicly about URZ many times (most recently here) as I believed it to be a uranium play that could be sustainable in almost any uranium price environment. While other parts of the world may offer certain advantages (like high grade in the Athabasca Basin), in a perpetual low price environment, grade isn’t “king” and URZ’s location and management technical and financial expertise would serve to separate it from the pack of uranium juniors. Though URZ returned -4.5% in 2014, it still outperformed its in situ (ISR) competitors in 2014 and also easily outperformed the sector overall which was down substantially more as I mentioned above.
Source: stockcharts.com
Overall, this is positive for URZ shareholders and represents a 37% premium to the closing price on January 2. It’s an all-share deal (.255 EFR shares for 1 URZ share) with a generous premium embedded. The deal also offers URZ shareholders the opportunity to benefit from EFR’s balance sheet strength and existing sales contracts. The combined contracts extend to 2020 which will allow the combined company to continue to generate revenue while developing a combined pipeline of existing projects in the United States. EFR’s ownership of the White Mesa mill, the only licensed operating uranium mill in the United States, is another plus. It accounts for 20% of US production and can handle additional capacity. URZ’s low cost profile will also benefit EFR, which produces uranium from conventional (hard rock) sources. This deal is a win for URZ shareholders.
This deal serves as an indication that M&A is likely the most effective method to generating excess returns in an otherwise hated and depressed sector. I also think it is safe to assume that more low cost supply will be consolidated going forward. Excess capacity reigns supreme in the uranium sector as it does for a host of other metals, but this will not always be the case. EFR management must have realized this and decided to act now while stakeholder interest in the sector is dormant. URZ’s low cost strategy paid off for shareholders and EFR’s strategy of consolidating assets in the current environment has potential to continue this trend as the uranium sector slowly comes back to life.
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