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Berkeley Energia, recent weakness in share price. Is it still a buy?

Disclaimer: Shareinvestors is not authorised by the Financial Conduct Authority to give investment advice. Terms such as ‘Buy’, ‘Sell’ and ‘Hold’ are not recommendations to buy, sell or hold securities, these statements and other statements made by the author have the meaning only to express the author’s personal views on the quality of a security. Independent financial advice from an authorised investment professional should always be sought before making investments. CAPITAL AT RISK. Full Disclaimer here.


I covered Berkeley Energia (BKY) back in October 2016 and it has regrettably been one of my most disappointing tips since I started writing on this website. Back then I tipped the share at 48p with a target of 80p. As at today, May 14th 2017 the share price still sits around the tip price, at 51p.  The share price did actually react strongly through to the end of January 2017, touching an intra day high of 71p, since then the price has been on a downwards trend though, reaching a low of 41p last week, despite rallying strongly again since. In this piece I take a look at what has happened since my initial tip and try to assess whether I still expect the Berkeley share price to go nuclear…

QUICK FACTS

Berkeley Energia is focused on bringing its 55 Million Pound (lbs) Uranium mine at Salamanca, Spain into production. I refer to this as the ‘construction project’ throughout. This project is expected to be completed in 2019 with the first Uranium production expected towards the end of 2018. The company states project economics are strong even in the continued low uranium price environment. Major hurdles left on the project prior to full construction are the financing and the final permits. The company also has some interesting ‘near mine’ exploration prospects which could bolster the economics further.

The Share Investors full research report can be downloaded here, this is an extensive research pack, which complements this article for the ‘number connoisseurs’ amongst you.

Snapshot of data as at May 12th 2017:

Current Share Price 51p
All Time High 71p – 17th January 2017
52 Week Low/High 71p – 17th January 2017
30.2p – 16th May 2016
Market Capitalisation £139m
Enterprise Value £116m, includes Net Cash £23m
Fully Diluted Market Capitalisation £139m, some options outstanding
ShareInvestors Risked Valuation £251m, 0.71p per share (40% upside)
PE/EPS N/A
BKY Share Price.png
Fig 1. 5 Year Share Price. Source – Yahoo Finance

THE RECENT DEVELOPMENTS DISSECTED…

Before you proceed, please familiarise yourself with my earlier piece here which will give you a gentle introduction to the company.

You’ve read it… on to the recent developments then:

1) Further Zona 7 Deep Exploration Success…

The company announced in Mid March 2017 that the company had yielded further success with the exploration drill bit. The company revealed that further additional high grade intersections has been encountered below the Zona 7 deposit through two recent exploration drills, Z7M-376 and Z7D-379. This complemented the previous exploration announcements on September 2016 here and January 2016 here, giving a total exploration program of 17 holes.

The exploration drills reported this time around reported grades as high as 0.38% (3,761 ppm) of Uranium, albeit for small sections. I’m not a geologist and I struggle to interpret all of the drill results and corresponding grades, but the overall conclusion when assessing the entire exploration programme is that it appears that grades seems inline with the existing Zona 7 deposit, which forms part of the up and coming construction project. This is important as the findings could mean that we have one or both of a) an extension of the existing envisaged mine life and/or b) potential to extend the production rates become distinctly possible.

Berkeley Energia have kindly supplied a graphic in Figure 2 for the non geologically minded which helps me at least visualise the above results somewhat showing an overview of the various exploration drills to date. Drill Z7R-360, drilled in September 2016 is highlighted in blue together with the corresponding grades at each depth. Figure 2 also outlines how the deposits could look, with the existing Zona 7 forming part of the construction project being the deposit closest to the surface in figure 2:

z7-1024x7201-1024x720.png
Fig 2. Zona 7 Exploration Drills. Source: Berkeley Energia

The results are clearly promising but it is also worth nothing though that the company has spent around $A20m (£11m) on exploration work in 2016 and 2017 and thus rationally cannot keep going with this when the company has an expensive construction project to fund in situ. The company though informed us in the same RNS that:

…discussions have commenced with strategic partners to fund an exploration joint venture designed to delineate additional resources to extend the mine life or expand production.

The partners would be expected to bring extensive multi commodity exploration experience and the very latest expertise that could be applied to the large body of structural and mineralising events at the project.

It seems like a smart move, the company does wish to continue to try to prove up additional reserves in conjunction with the completion of construction but thinks the best way to achieve this is to bring on a strategic partner by forming a Joint Venture (JV). The substance of how any Exploration JV will look; we don’t know, I suspect though to conserve cash for the construction project that Berkeley Energia will be looking to enter some sort of ‘carry’ arrangement where a partner will get an equity share of the exploration acreage in exchange for covering the future exploration costs. A historic back costs rebate could also come into play which would obviously go towards the financing needs of the Construction project.

In summary this exploration area remains an exciting upside, especially when the company reminds us that just 7% of the company’s 1,160km2 has been explored so far. That said it is early days and pre JORC (independently approved resource/reserve estimate), so it is hard to assign a value from an academic perspective of much beyond the back costs at present. Things could move quickly though if a JV is formed and exploration continues to yield success.

2) Construction gathers pace…

The company provided a construction update in late April here. Berkeley Energia told us that everything is on track, the majority of the land acquisitions have been made and key items such as the crushing circuit are being fabricated as we speak(read). Also rather encouragingly the order of the first items associated with the crushing circuit came in at around a 20% lower cost than was anticipated in the Definitive Feasibility Study investment case.

Further detail was also added on the construction progress in the Q3 financial report, although the only item of interest for me was the discussion around permitting, buried in the details the company reminds us that:

The Company is fully permitted for all the work it is currently carrying out in preparation for full construction.

With the Mining Licence and Environmental Licence already obtained, the next approvals comprise the locally issued Urbanism Licence and the Construction Authorization by the Ministry of Industry, Energy and Tourism for the treatment plant as a radioactive facility, and which are currently in process.

The permitting is the only item at present which is making me nervous about the ‘project execution’. There have been some negative stories in the local press recently, which is fairly unsurprising to me, for anything nuclear it is pretty much ‘par for the course’ to receive objections.  However, could continued bad press influence these permitting processes? CEO Paul Atherley addresses this in the recent investor Q&A describing various pieces of ‘fake news’ from local Green protest groups. Paul also reassured investors that on top of dismissing the protests as fake news ‘a la Donald Trump’ (my words), the company is engaging with local stakeholders and ensuring the elements of the firm’s Corporate Social Responsibility (CSR) programme are also being clearly communicated to the community. So hopefully this is something the company can control.

Last but definitely not least, the company also reminds us it is still working hard on raising the $200m or so ($95m initially) it needs to finance the construction project, but as yet it has nothing to update us on. This is not a major issue as cash balances look healthy at $38m as at March 2017 and are enough to get us under way with construction…

THIS ALL LOOKS ROSY, SO WHY HAS THE SHARE PRICE DROPPED?

There have been a few events to note since the share price hit an all time high of 71p in January 2017. Global X Uranium Fund purchased an initial 5% which latterly moved up to 6% of Berkeley Energia after the company was included in the Solactive Uranium Index. This index aims to track the total returns from the Uranium industry and can be seen as the closest proxy to the uranium price (as mentioned in my earlier piece there is no spot market for Uranium). This ETF has had a 52 week high of $19.33 and a low of $11.68, VOLATILE! The issue of including a relatively illiquid stock like Berkeley Energia, i.e. where just 0.19% of shares change hands on the average day in a much more liquid ETF is that it can create big price movements in the underlying issue…

This is exactly what Paul Atherley claimed had happened in the recent investor Q&A. Paul notes the recent spike and retrace in the Uranium spot price (spot being really an approximation published by a consultancy firm) which caused redemptions in the ETF and forced the sale of underlying holdings, including our beloved BKY. The logic does appear to make sense, albeit that it doesn’t completely stack up for me as we have had no TR-1 for Global X since the notification that they had 6% here.  In addition what Paul fails to acknowledge is that we have had what appears to be a disposal of shares from BlackRock here, taking them under 5% and therefore beyond the reportable requirement. It is probably the safest assumption to assume they now have nil shares. I do note that Berkeley Energia are still proudly showing BlackRock as a partner in the latest company presentation though, so perhaps I am wrong.

The other catalyst for the share price was a HOLD recommendation and Share Price target of just 60p from Liberium Capital, which was issued Late February. I have not been able to view the research as it is only available to paying institutions. As far as I am aware though the research was independent and thus should be taken note of, furthermore this target was published shortly before BlackRock made their disposal. The share price was actually around trading at 60p at the time of the Liberium research being published, but it may have convinced BlackRock that BKY was fully valued, triggering a sale. Disposing of 14.75m shares in an average daily volume of 0.5m is not easy without knocking the share price back a bit!

In summary there hasn’t been any negative company news of note and the share price was likely knocked by technical factors, i.e. big institutional sellers rather than on fundamentals. Note the share register still reads well, with big names such as Fidelity holding strong so nothing which worries me outright.

The price actually reached as low as 40p but has though started to recover this week, with the share price recovering back above the 200 Moving day average to close at 51p on May 12th 2017. So does this mean there is now a buying opportunity? Lets look at the valuation…

WHAT IS AN APPROPRIATE VALUATION FOR BERKELEY ENERGIA?

For a company with a market capitalisation of just £130m the stock is fairly well covered by brokers. (Hats off to Paul and the team, no wonder the IR team have been nominated for IR team of the year at the coveted stock market awards!).

Brokers have set targets as outlined in figure 3:

BKY Brokers
Fig 3. Berkeley Energia Broker Targets. Source: Hargreaves Lansdown

I pre warn you I get a little technical from here on…

As you can see my own price target is 71p, which is also outlined in a detailed financial model here, for those who want the detail. For those who don’t want to wade through 50 pages of figures, here is the ‘sum of parts’ valuation for the Equity:

bky dcf
Fig 4. Berkeley Energia Equity Valuation. Source: ShareInvestors.co.uk

I’m not going to explain my calculation in any detail, but feel free to contact me or leave a comment below and I would very happy to explain it further to any curious folk. At a high level though I have been more prudent on the Uranium Prices than the company and particularly in the research note from WH Ireland, the house broker. The only evidence we have for pricing so far is an offtake agreement with Interalloys for 2m/lbs over 5 years, which has an average fixed price of US$43.78. I have therefore taken this as my Uranium price assumption and then made an allowance for general increases in Uranium prices. There are of course people much cleverer than I who are predicting uranium prices of US$65 per lb from 2020, which I discussed the merits of in my other piece here. To me though forecasting commodity prices is inherently problematic and thus I always like to take a huge margin of safety, hence sticking with the price we know – afterall the price is the price until the price isn’t the price.

The other key assumption behind my valuation is to assume the project is funded 50% equity/50% debt, which obviously involves the number of shares that the NPV is being over being larger than the current number of shares in issue. I am well aware of course that the intention is to bring in a partner, but any partner will be taking equity type risks and therefore in my view will want equity type returns. I don’t believe swapping equity for partner stakes will materially alter the valuation either. It will though be preferable for the company to try to bring in a partner at project level as opposed to issuing fresh equity in ‘TOPCO’. The reason being that whilst the NPV per share differential will be immaterial in the short term, in the long term as the company brings on more projects more of the equity value will be preserved. The financing package is discussed in more detail below.

Final key assumption is that I have applied a risk factor of 0.7 to the Salamanca Construction Project Valuation and 0.3 to the Inferred Satellite resources valuation. These risk factors are actually more generous than WH Ireland. Instead I have been more conservative in my commodity price and finance assumptions, my risks factors therefore represent remaining construction risk and the appraisal risk for the satellites respectively.

I also include something in Figure 5 for those who are not au fait with NPVs, DCFs etc. This shows how the Free Cash Flows and Dividend Yields look based on my valuation, which I hope is informative for those without all of the technical knowledge:

bky_FCF
Figure 5, Berkeley Energia FCF and Dividend Yield Projections. Source: ShareInvestors.co.uk

UPSIDES AND DOWNSIDES TO THE VALUATION

As mentioned above, my base case valuation is 71p per share, but there are some core upsides/downsides to the valuation you should take note of:

1) Uranium price

I have performed a sensitivity analysis in Figure 6, showing the effect of CAPEX budget increases and the long term Uranium price on the overall company valuation. Given the low CAPEX required to bring Salamanca to production it is of no surprise that even a 20% increase in the CAPEX budget only reduces the risked valuation by 5p a share, i.e. from a base case NPV per share of 71p to 66p.

The long-term uranium price though has a huge effect, a long term uranium price of $US20, i.e. somewhere around a current ‘spot’ price would yield a risked valuation of just 6p per share, yet a price of US$65, i.e. the figure quoted by the ‘experts’ would double the risked valuation to 141p.

bky uranium vs capex
Fig 6. Sensitivity to NPV of CAPEX Overuns and Uranium Prices. Source- ShareInvestors.co.uk

As Uranium is negotiated on long-term offtake contracts though, any increases in Uranium spot will not necessarily translate into the valuation…

2) Securing Further Offtake Agreements

There becomes a slightly double-edged sword as result of supplying Uranium on long term contracts, the company can sign more offtake agreements and protect more equity value (see the financing discussion next) but signing too many offtakes could potentially cap future returns in the current very low uranium price environment. There is no right or wrong answer here and unfortunately for Paul Atherley I am sure Captain Hindsight will be out in force on the bulletin boards at some point in the near future.

To illustrate the current position, here on Figure 7 is an overview of current offtake agreements vs. total production. As you can see, very little has been committed though offtake agreements, in fact just one offtake agreement has been signed to date:

bky_ofttakesvsprod
Fig 7. Production vs Offtake Agreements. Source: ShareInvestors.co.uk. Note – production profile is slightly different to that published by company.

The more bankable offtake agreements are in place, the more likely the company will be able to include a greater proportion of debt in the financing package. I haven’t done the sums but in a perfect world, perhaps locking in 50%+ of the first few years production would satisfy debtholders whilst still giving Berkeley Energia upside to the alleged higher uranium prices post 2020.

But how critical to the equity valuation is it to secure more debt and less equity funding?

2) Financing Mix

The financing mix is pretty important and explains why the company has made it clear to investors that they will aim for the least dilutive form of funding. Note for the purpose of the below I consider convertible debt and project level equity finance tantamount to equity (as already explained above).

In summary, assuming an interest rate of 10% on debt, I calculate an unrisked NPV per share of 86p for 0% equity (100% debt) and 64p for 100% equity. My base case assumed a 50/50 capital structure giving a 71p unrisked NPV Per Share.

bky debt equity
Fig 8, Sensitivity to NPV of Differing Debt/Equity Ratios. Source: ShareInvestors.co.uk

As already mentioned I feel further bankable offtake agreements would be needed to secure 100% debt funding. Even then Berkeley Energia needs to borrow approximately 200% of its current market cap to fund the complete construction at Salamanca, so this is no small amount, but I do still feel a 50/50 debt/equity mix is achievable. That said It will be challenging, I very much doubt the debt market is awash with potential lenders to uranium projects,

Final comment – It is also worth observing that even paying a very expensive 15% interest rate on debt is still preferable to taking on equity based on my calculations.

3) Consenting Delays

The construction project I am told is fairly straight forward from an execution standpoint, therefore the only forseeable material holdup I can see is a delay to the permitting process, as discussed above. The very worst case scenario would be for a denial of the remaining permits, spelling the end of the project (Share Price=0). It is hard to see this given the 2,500 direct/indirect jobs the mine is claimed to create. That said the Spanish are not known to have the smoothest bureaucratic processes and a lengthy delay does indeed still have the ability to be a material value destructor.

4) Exploration and Inferred Resource Progress

Again, covering old ground but as further work on exploration progresses and more of the inferred resources can be upgraded to reserves takes place then further material upside on the valuation is probable.

SUMMARY

BUY – 71P Target (40% upside)

It should be noted that Paul Atherley and team have done a superb and professional job and have made rapid progress developing this asset in the last two years. The calibre of the management attracts me immensely to the share. I have though gone beyond my ‘gut feeling’ and prepared a fairly conservative valuation and still come up with 40% upside from here.

What I particularly like about the share is that on top of the clear value in the ‘base case’ there are some serious re-rate levers here too in a) the uranium price but also with b) the near field exploration work. On the former it is hard to see too much downside to the uranium price from here, but obviously it works both ways and the uranium price also has the potential to be a serious de-rater too and if the ‘spot’ price doesn’t at least climb back to $US30 it is hard to see too many more offtake agreements being signed at north of $US40.

Berkeley Energia is still what I consider a speculative investment, so don’t completely fill your boots but I believe the risk/reward to be favourable at present. Ceteris paribus, I expect this share to return to 70p by the end of the year (if not much sooner), save for a disappointing financing package, a permitting catastrophe, a black swan or a failure in any meaningful recovery in the uranium price.

Good luck!


Disclaimer – I have a potential conflict of interest regarding the company Berkeley Energia. I have a LONG position estimated at 4% of my Net Assets. I receive no other financial or non financial incentives for publishing the post. I will not initiate any further positions in the next two trading days from the date of the post being published.

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.

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