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Berkeley Energia the company focused on bringing its flagship Salamanca Uranium Project in Western Spain into production has enjoyed a cracking 12 months. The shares have increased 122% during the period capitalising the company at £88m at 48p a share. However with Uranium prices cratering to a 11 year low to $24.4 per lb, is it really a good time to develop an Uranium mine?
What is the Salamanca Project?
The Salamanca project is a uranium mining project with a potential resource of upto 82.6 Million Tonnes or 89.3 Million lbs of Uranium. The project is the only major uranium mine being developed in the world today, albeit perhaps that isn’t a major surprise given where the prices are. However, what makes this project somewhat unique is the low capital cost, just $95m and the operating cost per lb of just $13.30, thanks to good grades and shallow deposits. This means even at current spot price this is a 50% gross margin. No great surprise that broker WH Ireland estimate the NPV of the project to be a healthy $699m (£525m) using an assumed long term uranium price of $65 per lb (prior to financing). This gives a shareprice of £2.78p, so compared to current share price of 48p there is a lot of potential upside in the valuation, especially given that the construction appears low risk. WH Ireland believe an appropriate risk for the project is 40% and even on that prudent basis this gives a share price of around £1.20, i.e. 100% near term upside with potentially more to come once construction is complete, which by the way is around 2H 2018.
So the $95m project is pretty much ready for the shovels in the ground, the project is fully consented with the only missing milestone being the financing. In that regard Berkeley Energia announced on 19th September that it has appointed a second broker, Peel Hunt so it is clearly looking to start this process soon.
How will the funding affect the valuation?
The preferred method of funding the project is through bringing in a JV partner. This will crystalise some of the NPV already and likely mean Berkeley can self fund its share of the construction. Another possibility if a JV partner can’t be found is a combination of debt and equity. I would expect around £20m-£30m of equity with the remainder being debt. Given the low up front CAPEX cost and rapid free cash flow generated I do not expect the valuations referred to above to be materially impacted by the funding needs.
Any other positives?
No offtake agreements have been signed yet but the first Letter of Intent(LOI) has recently been signed for 1 million lbs of Uranium, this covers a period of 5 years. The counterparty to this agreement is Interalloys, a commodity trader which specialises in early stage offtake agreements. This LOI represents around 20% of the expected production per year once the site is fully ramped up, or 1.2% of the total reserves. The current average price envisaged by the LOI is $41 per lb, well above the current spot price, the LOI also refers to a combination of fixed and variable pricing, i.e. so Berkeley can benefit from any upside in prices but also cap the price to retain positive margins. This is a positive step but two caveats; 1) the average price is well below the $65 assumed in the NPV calculation above. Using the envisaged $40 per lb Uranium price gives an NPV of around $288m (£221m), all other things being equal. I’ll go on to discuss the risks vs. current valuation below. 2) This is a LOI, so not legally binding, although Berkely Energia expect this to be converted into a legal offtake agreement later this year.
The other positive is the management team, they are led by Paul Atherley who seems to have good experience. Berkeley Energia is also an analysts dream, the investment case is tangible and quantified with hard facts and figures in the Investor Presentation. This to me is a sign of good management and immediately fills me with confidence. It’s no surprise therefore that some heavy weight institutions have bought in, including Fidelity.
What are the Risks?
As mentioned above the low uranium price is the biggest risk to the company. The largest demand for uranium is the Nuclear power industry, which is deeply unpopular at present, this being largely as a result of the most recent disaster in Fukushima. This has forced all countries with include Nuclear as a major part of the energy mix to question the role it plays. At present the US is a big demander of Uranium and yet the United States Energy Information Administration (EIA) doesn’t expect any growth in U.S. nuclear power between 2015 and 2040, so where is the demand going to come from? This could be questioned, we have seen an explosion of offshore Wind in Northern Europe and a sign of a fledgling industry also developing in the US. This could be seen as a threat to the Nuclear Industry but Offshore Wind is limited in how much it can contribute. Therefore both Nuclear and Gas fired plants remain to me to be an important part of the Energy mix for the foreseeable future.
The bull case points to China and Russia being the most likely countries to continue to build reactors to satisfy domestic demand. There is a good pipeline of reactors in progress and industry analysts also expect a number of long term offtake agreements to expire in coming years. The demand side does look more positive in future years, but what about supply side?
Around 40% of the worlds current production is split between Canada, Australia and USA and much of that production is marginal or loss making at current spot price, as shown in Fig 3 below. You would therefore expect that sustained low prices may take some production offline which should provide upwards price pressure. Cameco has the highest production costs, some $9 per lb above current spot price. The company is burning through cash but not yet in financial distress, it has also moved to mothball some more unprofitable operations.
The good news for Berkeley Energia is that it will be the lowest producer in the world once the mine becomes operational (See Fig 3 below). However, Russia and China have over 10% of the worlds discovered uranium reserves between them and increasing domestic demand would likely step up increased exploration efforts on their own turf. Past experiences tells us that China and Russia do not like being dependent on commodity imports and these are vast countries where large undiscovered reserves are likely. So this does not necessarily mean they will continue to offtake from the current supply chain. If China and Russia do look to develop their own production sources then I expect the marginal cost of production to come down, supply to increase and hence the price of uranium to stay lower. However, the development of mines takes time and with the possibility of more expensive production being taken offline the current conditions do seem to suggest a spike in the prices is likely, at least for a short while.
What does the business case look like though if uranium price stays low?
The range of NPVs from WH Ireland based on average uranium prices for $20, $40 and $65 are compared to market capitalisation below, for illustrative purposes. (Note – based on current FX rate of 1.30 GBP:USD, as with all resource stocks be mindful of the risk of a strengthening pound and ensure portfolio appropriately hedged.)
SPECULATIVE BUY – Initial Target 80p to 2017 end i.e. 66% upside. This capitalises company at £145m and still well below the $40 NPV case .
I fully expect the project to be funded and further offtake deals to emerge. Construction seems fairly low risk too which leaves the key risk as the Uranium price. I am aligned with the bulls in that there does appear to be the ingredients for a mid term supply crunch, I am less convinced regarding the long term uranium price but any significant uptick in prices may create opportunities for Berkeley to prolong the upside through an appropriate hedging strategy. Ultimately the risk/reward play looks attractive at current levels.
Disclaimer – I have no positions in this stock and to my knowledge nor do any close family, friends nor associates. This post is purely my opinion and should not be taken as financial advice. I welcome any alternative comments and will consider adjusting posts based on information made available to me.