Before I recommend a way to play the current uranium market, here’s a quick recap of why prices – as I said last week in my uranium forecast – are bound to rise.
First, although it may be counterintuitive, the Fukushima disaster hasn’t cooled attitudes about nuclear power outside of Germany and Japan. New nuclear plants continue to be built and existing ones are being expanded.
Second, on the supply side, the expiration of the Megatons to Megawatts programs will remove 24 million pounds of uranium from the market each year.
But here’s the rub: Currently low uranium prices simply don’t justify expanded production, and this is preventing the industry from readily meeting the market’s increasing demands.
For producers, it’s a simple consideration. When deciding whether to extract uranium from the ground, you can estimate how much it will cost and exactly what price per pound of uranium will make that mine a profitable venture. Currently, that price per pound is $83, and unless uranium hits it, we’re not going to see a boost in mining.
Such expanded mining operations are a long time coming, too. Uranium’s price bubble in 2007 led to lots of new exploration, but the bubble didn’t last long enough for any significant production to take place.
As a result, many uranium properties are stuck in the pre-production phase. Now consider that glut in the light of the life cycle of a mining stock, which follows a predictable path.
The bulk of small uranium stocks are in that long lead up to actual production, but still not there yet. For most, there’s plenty of time left before legitimate production provides a lasting boost to share prices.
Instead, now’s the right time to buy into uranium companies with already fully developed and productive mines…
Cameco: Big and Getting Bigger
One such company that already has a full suite of production facilities is Cameco Corp. (NYSE: CCJ), which accounted for 16% of world uranium production at 22.7 million pounds in 2011. It’s nearly a pure play, deriving 79% of its profit directly from uranium.
The company has five different, productive locations.
The largest, McArthur River, produced 18.7 million pounds of uranium in 2011, of which 13 million pounds went to Cameco as a 70% owner. Currently, McArthur River has a projected production life of 24 years. Cameco plans to boost that production to 22 million pounds per year.
It also owns smaller, but still productive, mines at Rabbit Lake (Saskatchewan), Smith Ranch-Highland (Wyoming), Crow Butte (Nebraska) and Inkai (Central Kazakhstan).
Even though it’s already a major producer, Cameco has plans to nearly double annual production from 22 million pounds to 40 million pounds by 2018.
The biggest increase will come when it begins production at Cigar Lake in Saskatchewan. Mining development there has been delayed by flooding multiple times, but management now expects production to start in 2013, peaking at around 18 million pounds per year.
Look for Cameco’s stock price to move with uranium prices, but not in lock step. Due to the long-term nature of its supply contracts, the stock has a correlation to uranium prices of around 70%. That correlation works both ways, though, and a black swan event like another Fukushima disaster could always complicate our predictions. Still, Cameco’s contracts work to our benefit, acting as a cushion to any such downside.
With Cameco’s average cost of production around $25 per pound, and an extra 20 million pounds of annual production in the near future, even small moves can turn into serious earnings. So despite the long-term contracts, prices at $60 per pound would boost earnings around 20%. Considering that Cameco’s trading at just 18 times forward earnings – well below the 37 times it traded for in 2010 – that could mean a significant rise in share prices.
Bottom line: With uranium prices set to rise to $80, I project that many more mines are going to come on-line. Exploration companies and development stage mines are always tempting. But until they get close to production, the smart play is to bank on a major producer like Cameco that you’re sure will follow uranium’s climb.
Ahead of the tape,
P.S. - While Cameco has a great combination of safety and return potential, in this month’s WSD Insider I’m going to talk about a smaller uranium mining company far more oriented toward growth. To find out more about this company’s amazing investment potential, click here.