Guest Feature: Everything U Need to Know About Uranium

by Matthew L. Kelly

Introduction

Nuclear energy is often distinguished from its renewable and fossilized competition in terms of environmental sustainability and engineering might. But what about economic efficiency? Uranium prices are up since 2016. Why? Are nuclear companies maximizing shareholder value? Let’s put market trends in context by studying the financial fundamentals of uranium producers.

Market Background

The largest producers are nationally owned behemoths like Kazakhstan's Kazatomprom (KAP) and France’s Orano. Orano is not publicly traded, but 25% of KAP trades on the London Stock Exchange. Nationals sometimes waste money meeting politically determined output goals. Enterprising private sector miners in the US, Australia and Canada instead must answer to shareholders, who exert a strong incentive to conserve resources and continuously improve operations. Thus, the now pervasive “in situ leach” solution mining method was pioneered in Texas, not the Steppe.

In market economies, this capital intensive industry cycles between expansion and consolidation. Rising prices encourage a cohort of upstarts to explore new deposits. Meanwhile, established players with higher debt capacity acquire rivals and suppliers to exploit potential synergies of diversification. The uranium market is not huge. About $10 billion was purchased in 2021, $1.5 billion of that from the US. Uranium miners and related companies have a total market cap of about $30 billion. But against tall odds, optimism for growth abounds.

Uranium producers depend on government spending and face strict regulatory scrutiny, but private investors remain a vital source of capital. Shares of at least 115 uranium related companies are traded on stock markets around the world. Most uranium sales are conducted directly between producers and utility companies via 3 to 15 year contracts. Utilities normally pay a premium over the spot price to secure long-term supply. Product quality can vary depending on a plant’s needs. The standard futures contract unit is 250 pounds of U3O8, traded globally on the Chicago Mercantile Exchange at various maturities. Speculators and financial intermediaries constitute more than half of average trading volumes, providing liquidity in exchange for a spread. Spot prices can exceed contract prices if utilities need to top up in a pinch after failing to anticipate demand. Miners naturally prefer high prices and low input costs. Fortunately for consumers, prices tend to fall in the long run as productivity improves.

Recent breakthroughs in nuclear fusion and new reactor designs have captured the attention of forward-looking tech investors. Fewer commercial companies engage in highly-regulated enrichment, but that research-intensive link in the supply chain has also been responsible for substantial fuel efficiency improvements. Furthermore, it is becoming easier to recycle uranium from old weapons and partially used fuel. These innovations tend to lower demand for mined uranium because plants can get more from less.

Still, 77% of 2021 supply came from traditional miners (down from 94% in 2012). Mining is a fiercely competitive, long-term, high risk business. Mining stocks track commodity prices closely, but international firms are also exposed to the risk of appropriation. Uranium demand is fairly predictable, but finding value underground is an inherently costly, uncertain venture. Fates are decided by geological feasibility studies. Even if exploration leads to proven reserves and permits are granted, it can take years for extraction to yield profits. Most “junior” miners fail to find deposits, let alone stabilize revenues and build the cushion of liquid capital needed to weather price volatility. Successful juniors are typically bought by established “major” miners. Juniors and majors live in symbiosis, sharing risks through specialization. Juniors bear the high risk of exploration, eventually feeding new mineral deposits to dividend-paying majors and their risk-averse institutional shareholders. Because energy is capital intensive and revenues so volatile, liquidity is prized and debt discouraged. Shareholders enforce a harsh discipline, jealously protecting cash if and when it finally flows. Mining stocks remain popular investments because the business is simple: find, extract, sell, minimize costs, eschew debt, repeat. Simple but uncertain. As with gold, diamonds, cobalt and oil, so too with uranium.

There is a budding, if still contrarian conviction that more nuclear power would improve energy reliability and efficiency. However, technical efficiency does not always mean economic efficiency. Lots of neat projects fail to make a buck. Growth seems more probable now as high energy prices evince decades-long underinvestment, but the high cost of lengthy plant construction requires patience. Public subsidies may be the ticket, but private financing materializes through equity issuance and consolidation. Fuel efficiency gains may have shrunk miners’ incentives, but vertically integrated supply chains can capture the profits needed to invest. Thus, mergers and acquisitions will probably quicken if demand rises further.

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Nationals

The financial health of a nationally owned enterprise like Kazatomprom (KAP) depends on the stability and development of its nation. Uranium producing Kazakhstan has embarked on limited economic liberalization, but politics remain quite illiberal. In 2019, presidential power changed hands for the first time since 1990, yet this mostly symbolic transition belies an entrenched ruling party. Based on a survey of 290 mining and exploration companies, Kazakhstan ranks just 65th in terms of investment attractiveness. KAP shareholders and foreign joint venture partners face the risk that Kazakhstan’s codified property rights will be “reformed” (read: disregarded or selectively enforced). Some analysts worry that rising commodity prices and high sovereign debt is a recipe for resource nationalism. Threats to KAP’s revenues include lingering supply chain challenges, civil unrest, shipping security in the Baltic and Caspian Seas, and possible Western sanctions. In 2022 re-exports to Russia spiked and uranium exports doubled, but the former Soviet Satellite also avoided shipping routes through Federation territory and rhetorically distanced itself from Putin. That’s a fine line to walk.

In 2021, KAP produced a whopping 45% of world uranium supply. Output is not an unambiguous measure of value, however. Partial privatization in 2018 may have precipitated recent output cuts meant to ensure returns to scale are better optimized. KAP concentrates on mining, exporting nearly all of its ore for others to process and consume. Frenetic prices arising from the whims of bulls and bears now provide a fresh signal of KAP’s perceived worth. Those willing to hold KAP’s risks earn a sizable premium. At the moment, investors are satisfied to pay 15.46 times KAP’s earnings (compare this to an average PE ratio of 109 for the total market, 83 for renewable energy, or 32 for metals and mining) and demand a hefty 6.25% dividend yield (compare this to the S&P 500 average of 1.74%, or Canadian competitor Cameco’s 0.35%). KAP’s market beta (0.54) indicates low correlation with the broader market. Yet, since shares were issued, returns outpaced other major miners’, as if to compensate for greater risks involved.

Despite investor hesitancy, KAP’s financial statements mostly portray success. Revenues have doubled since 2017, totalling $1.62 billion in 2021. In 2021, the gross profit margin was 41%. Net profit margin was a respectable 32%. Return on Equity (ROE) and Return on Assets (ROA) were both high at 30%. Midway through 2022, assets totaled $4.7 billion, and equity totaled $2.31 billion. KAP has maintained more equity than liabilities since at least 2017. Its current ratio was 4.84 in 2020, indicating sufficient liquidity, given its loose borrowing constraints (liquidity tends to be higher in mining than in most other industries). Like other miners, KAP has accumulated cash in recent quarters, perhaps fortifying itself against price volatility ahead. Most of KAP’s debt is long-term, and with a debt-equity ratio of 0.07, the firm does not look overleveraged. Interest expenses declined after 2018. Inventories remained roughly constant in the last year, but property, plant, and equipment assets shot up in the first two quarters of 2022.

This indicates KAP is having no problem moving product and is pushing to further develop operations. According to KAP’s statement of cash flows, annual free cash flow grew an impressive 518% between 2017 and 2021. With demand growing, receivables turnover rose just above 1. This troublingly low ratio suggests KAP lends generously to customers in order to maintain market share. Overall though, it is difficult to justify KAP’s high risk premium by its books alone. Skeptical investors must fear geopolitical machinations. They may also be penalizing KAP for a lack of diversification, since the long-term demand for raw uranium will likely fall as plant efficiency improves. Indeed, with a payout ratio of 68%, investors might happily forgo dividends in the short term in exchange for needed reinvestment into new growth opportunities.

Second in world production is Orano at 9%. Unlike KAP, this company looks over-diversified. Outside France, it operates in Namibia, Gabon, Canada, Kazakhstan (through joint ventures with KAP) and elsewhere. Orano mines, enriches, stores, recycles, and even develops medical treatments. What can’t it do? Turn a profit, that’s what. In the uranium bull market of 2022, Orano’s net income was negative. Net income turned briefly positive in 2021 due to some new contracts, having been red in 2020. Chronically negative free cash flow and other problems led to a rebrand in 2018. Orano has zero equity on top of $23.1 billion in assets (although French government accounting standards - which I won’t pretend to understand - are less than perfectly clear on this point). Orano has worked to reduce its leverage since 2017, with total debt falling another $200 million in 2022. That’s encouraging, but a company that cites EBITDA 7 times and never mentions EBIT in its annual report deserves chiding. Nearly every other uranium company increased cash holdings in 2022. Orano’s decreased. The current ratio was a dismal 0.42. Revenues totaled $44.8 billion, but this company needs to sell some assets or fold. Unwilling to let this sector shrink, France nationalized its other overleveraged nuclear giant, EDF. Mismanagement seems to fester without a robust market for corporate control. With recent outages, and waste storage approaching capacity, capital budgeting is more and more a political decision. Orano exports fuel at a loss as French citizens foot the bill. One wonders what Frederic Bastiat would pay for this plate of stinky cheese.

Let’s see how the private miners fare.

Majors and Friends

First, an arbitrary assumption: label any uranium miner with an enterprise value greater than $3 billion a major. To understand relative values at different stations in the structure of uranium production, consider the balance sheets of major Cameco (CCJ) and components supplier Babcock and Wilcox Company (BWXT). Contributing 9% of global uranium production in 2021, CCJ has a market cap of $12.45 billion and trailing 12-month revenues of $1.38 billion. CCJ conservatively stopped buying new fixed or intangible assets just when uranium prices began trending upward in 2016. Growth in investment assets also stalled after 2019. The lull has now ended, as CCJ prepares to acquire a 49% stake in Westinghouse Electric, a company well downstream of CCJ’s existing business. Vertical integration! The firm is in good financial health for the deal, with a debt-equity ratio of just 0.18. CCJ’s total assets hover around $8 billion, with equity far outstripping its $1.34 billion in debt. The firm is cash rich, with a quick ratio of 4.9.

BWXT is smaller (market cap $5.5 billion) and younger, but its assets grew 66% since 2016 to total just $2.5 billion in 2022. To pay for that, BWXT borrowed $1.5 billion. That’s twice the total debt of CCJ, making BWXT’s debt-equity ratio the highest of any private uranium company (1.88). Like CCJ, BWXT is on a quest for growth and diversification, but borrowed more and started from a different link in the supply chain. So far, the firm lacks a foothold in mining. Timing has been start and go. Just before the 2016 uranium price inflection, BWXT spun off its power generation segment in exchange for a factory, cutting revenues in half to a quaint $400 million. This coincided with aggressive share buybacks, sending prices skyward. Since then, BWXT acquired a naval ships supplier, a medical isotope company and a nuclear materials firm. Capex is BWXT’s largest expense as a share of EBITDA. Hedge funds and other institutional backers (who account for 99% of shares outstanding) may provide BWXT with flexibility to use debt in an industry where higher order miners are penalized for borrowing. BWXT’s buyback eliminated all but the most patient investors, who now give it a lot of runway. Growing book equity suggests those bets might pay off eventually. In the near term, however, BWXT’s interest expenses could rise with higher rates, and higher uranium prices may squeeze rather than augment its earnings. Miners are piling up cash, but BWXT’s low quick ratio (0.5) adds a liquidity concern to worries about its debt.

BWXT does look more profitable than CCJ. CCJ’s revenues have declined 35% since 2008. BWXT’s revenues steadily grew 25% since 2016. Furthermore, BWXT stayed profitable through the pandemic, while CCJ’s volatile margins hit net losses in several quarters. BWXT (CCJ) had a gross profit margin of 30% (21%) in 2022, an operating profit margin of 15% (about 0%) and net profit margin of 14% (1%). BWXT’s Return on Equity (ROE) was almost 50% and Return on Assets (ROA) was about 12%. Compare that with CCJ’s meager 2% ROE and its paltry 1% ROA. Why would investors subsidize loss making CCJ when they can have that profitable, growing, downstream vintage BWXT? One must keep in mind that BWXT is taking on leverage to achieve those numbers, and part of why CCJ’s return on equity is so low is because its equity is so large already. For all BWXT’s accounting profits, CCJ pays the higher dividend. But momentum matters; BWXT’s dividends grew 16% in five years, whereas CCJ’s decreased 22%.

Which does Mr. Market prefer? Indicators are mixed. CCJ’s price-earnings ratio (177) is far higher than BWXT’s (17), but CCJ’s book-to-market ratio (2.89) is lower than BWXT’s (7.75). Long-term stock returns for BWXT outpaced CCJ by a healthy spread, but CCJ has performed better since 2020. The tie breaker here in CCJ’s favor is its dividend yield (0.35%), lower than BWXT’s (1.4%). At the moment, the bulls favor miners. Investors are sending capital upstream, paying a premium for higher order mineral sources and discounting lower order processors and utilities. Debt and exposure to rising interest rates may contribute to BWXT’s recent lethargy. Fortune is fleeting, but when it comes shareholders don’t want a dime going to creditors. Markets tolerate CCJ’s losses and dividend cuts because they expect future growth and know its cash flows aren’t mortgaged. Investors may also be counting on CCJ’s market power to protect it from competition.

Juniors and Friends

Uranium juniors outnumber the majors. Market caps are $434 million on average (not big). None of the juniors pay dividends. Only 3 had positive earnings. Stock prices for all miners, but especially juniors, usually move in lock step with assets and book equity at some multiple; mining is risky but not hard to price. It is rare that a junior miner will have significant debt. Many have none. The outlier debt-equity ratio in this bunch belonged to IsoEnergy Inc. (ISENF), at 0.41, although its respectable market-to-book ratio (5.02) and +500% 5 year return suggest the debt is warranted. Despite rising uranium prices, juniors have been unprofitable since 2020. Almost all juniors are very liquid, with current ratios ranging between 3 and 300. Half were greater than 10. Are they preparing to acquire new properties and mineral rights, or just insulating themselves from a potential price collapse? Most have no revenues, but those that do have high profit margins (about 30% on average) despite low (almost always negative) ROEs and ROAs. Most have busily accumulated fixed and intangible assets since going public.

Consider NexGen Energy Ltd. (NXE). Net income and cash flows declining; market value rising in step with assets and equity; debt kept low at just $200 million. ROA and ROE are consistently negative, but the firm is ridiculously liquid. NXE’s current ratio is now 8, but got as high as 50 in 2018. At a market cap of $2.24 billion, NXE is on the cusp of majorhood, but its book screams junior. A 7.29 market-to-book ratio sets NXE apart from other juniors. Investors expect growth.

Similar patterns jump out from the other juniors’ financial statements: declining income, and low profits amidst increasing liquidity. A tiny $10 million company with only 1.6% institutional ownership, Azincourt Energy Corp (AZURF) is typical in this regard. Net income is falling but the current ratio is 60. However, AZURF’s market indicators are extraordinarily infirm. AZURF is trading for less than its book! With a market-to-book of only 0.98, investors are pricing AZURF as if it is actively destroying itself.

Consider reactor technology company Lightbridge Corp (LTBR). A quick look at their financial statements don’t reveal any especially revolutionary innovations yet. Like the juniors, LTBR company is making deep losses and accumulating cash. Also like most juniors, LTBR is growing its assets. Silicon Valley has high hopes.

Among nuclear companies, Centrus Energy Corp (LEU) (market cap $700) is the standout. Despite new equity issues, stock prices rocketed straight to Uranius. LEU recently became the sole source of high quality HALEU fuel to be used in next generation reactors. Since 2017, revenues rose 54%. Thanks in part to tax refunds/credits, the net profit margin was 46% in 2021, higher than gross! Yet the quick ratio was less than 1 - illiquid. LEU’s long-term debt-asset ratio is greater than 1! Negative equity and negative retained earnings normally signal financial issues. The simple explanation for this anomaly is that LEU is in a class of its own. They make the fuel of the future and clutch a fresh pressed government contract. Different rules and expectations apply for this outfit. The firm accumulated fixed and intangible assets it will steadily depreciate. It pays to mine the raw material itself when prices are high, but apparently it pays even more to make a better, cheaper, more concentrated fuel when raw materials become expensive.

Juniors miners and explorers with little to no debt are rewarded. Take Energy Fuels, Inc. (UUUU). UUUU reduced its debt to zero from a high of $32 million in 2016. If the company does hit the jackpot, all those cash flows will be going to shareholders, not creditors. Investors are now willing to pay more than 700 times sales and earnings, and the market-to-book ratio has inched up above 4 since 2020. Fickle investors could lose interest if UUUU were to issue new debt. “If we can’t have you, nobody can!” the covetous shareholders cry.

Ur-Energy’s (URG) debt-to-equity of 0.18 was second-highest in the junior pool. Despite the $40 million in debt issued in 2013 (a lot for a market cap of $242.13 million today), cash flows to shareholders rose steadily after only an initial hit. URG paid off that debt. By 2020, only $12 million remained on top of $120 million in total assets. Keeping total debt constant since 2019, short-term debt was replaced with long-term, then reversed back to short-term debt through 2022. Retained earnings declined steadily since 2010, but URG seems adept at raising capital to increase cash flows when net income falls. Is all this switching between long and short debt part of that cash flow management? When URG issued new shares and warrants earlier this month, stock prices tumbled on the news. Investors were spooked that management might dilute shares without building value.

But zoom out to see that this modest price cut comes after a 66% appreciation in 5 years. URG’s market-to-book ratio is 3.73, ranking middle of the pack. URG could be more liquid (its current ratio is 5, not especially large by junior standards), but overall this firm is an example of a junior keeping its nose to the grindstone building reputation. The equity issuance will reportedly replenish working capital to help ramp up existing mines and ensure “readiness” for acquisitions, which sounds credible after purchasing $50 million new assets in 3 years.

Trends, comparisons, and opportunities

The uranium business is like any mining business on a smaller scale. Cameco’s $12 billion market cap pales in comparison to oil and gas giant BP’s (BP) $120 billion, or American mining company Freeport McMoRan Inc.’s (FCX) $60 billion. Indeed, the tiny scale of the uranium market may be what investors find enticing. Markets have a harder time pricing the exotic opportunities of small illiquid companies, allowing holders to earn a convex “size premium”. The extent of the uranium market has always been limited by the government, as well as public anxieties of disaster risk. Today, plans for new plant construction and demand increases are at least being discussed more publicly. Uranium investors and promoters hope stubborn zealotry for impractical wind and solar power - so central to the progressive environmentalist narrative - will give way to atomic realism.

Is recent price action the nucleus of investor optimism? Sprott Asset Management is credited with neutralizing the carry trade and propelling this bull market via its SPUT trust fund. Does the boom reflect fundamentals, the broader commodity cycle, or just inflation mingled with financial engineering? A look at relative prices may provide answers. If we divide uranium prices by a commodities price index published by the IMF, the uranium resurgence is muted. Prices haven’t risen relative to commodities. Why invest in yellow cake when I can earn as much or more investing in copper, natural gas, or agriculture?

We might ask if equities are cheap or expensive relative to raw materials in order to gauge whether markets perceive recent trends as an opportunity or misfortune. Relative to a commodities ETF (XME) uranium equities did run ahead of uranium’s relative price in Winter 2021-22, but have since come back to earth. Cumulative returns for KAP, CCJ, BWXT, and a Uranium ETF (URA) are plotted relative to uranium itself. Returns for majors relative to URA are also plotted. Mining focused KAP wins the horse race against its diversified rivals. CCJ gallops behind, followed by BWXT (whose fall probably also reflects interest rate exposure). Uranium stocks have also outperformed utilities since 2020. Thus, downstream businesses who buy uranium to process and consume are struggling while miners fatten up.

Source: Yahoo Finance 

It’s not obvious how long that balance will be sustained. Ultimately, it’s the price of electricity that drives the price of uranium, not the other way round. The cost of capital adjusts as the marginal productivity of different inputs change. As interest rates rise, the time value of money becomes dear. Investors demand higher returns at shorter time horizons. Higher interest rates can reduce share prices and increase the cost of capital for risky, long duration plays like mining exploration. “Your innovative pipedream can wait, young man. We need uranium now.” Competition among multiple firms with differing strategies ensures adaptability to changing taste and circumstance.

Each individual firm embodies the idiosyncratic risks of its peculiar assets, management, and station in the structure of production. But all firms can be thought of as commonly imbibing macroeconomic risks present throughout the business cycle. What kinds of systematic risks do uranium producers partake of? What can investors get from these companies that they can’t get elsewhere? To answer that, some risk adjustment is needed. Normalize excess returns by volatility to calculate the Sharpe ratio; return per unit of risk. Alpha is another risk-adjusted return measure, the component of average returns not attributable to economy-wide risk factors. A Fama-French style 6-factor regression analysis reveals that the factor most relevant for uranium companies is the market risk premium (when all firms do well, so do uranium producers).

Next is the size factor (when small companies outperform big ones, uranium producers do well (excepting giants like KAP), followed by the profitability factor (when profitable companies are flooded with capital, uranium producers suffer arid returns). Only 4 companies beat the market (GLATF, KAP, NVTQF, and LEU) in the sense of earning positive, statistically significant alpha. Table 1 presents Sharps ratios, alphas, and factor risk exposures for each company and ETF covered here. Companies are listed in descending order of Sharpes. For younger companies, these values should be taken with a grain of salt because there is less data available to base estimates on.

This analysis should give uranium investors pause. The relative price of uranium hasn’t changed much. There is little reason to allocate capital out of other commodities and into uranium but for a strong expectation of growth. One could replicate the returns of most uranium stocks by levering up on the market portfolio, overweight small stocks, and adding some inverse exposure to profitability. Juniors like explorer NVTQF and miner GLATF outperformed probably only because of one-off deals and unrepeatable discoveries. LEU’s stratospheric returns look more down to earth after adjusting for risk. The only big miner with positive alpha is KAP, whose excess returns probably reflect a geopolitical risk premium. Most miners seem to be riding a broader commodities boom fueled by inflation.

How sustainable is that? Increasing liquidity ratios could mean that firms expect turbulence. If inflation subsides on Fed rate hikes, so might the price of uranium. Expectations of the uranium industry invariably stem from a belief about what the government will or won’t do. If wind and solar subsidies stop, a real boom could follow as utilities seek out the cheapest, most abundant energy sources absent preferential incentives. If more follow Japan by expanding capacity, perhaps valuations will improve further. Mr. Market is not excessively exuberant on the matter. Market valuation ratios for uranium miners are not yet outrageous. The total market average price-to-book ratio is about 3.89. For renewable energy companies, the average is 6.8.

Market conditions may not be as ideal as they appeared at first glance, but are miners making the most of it? Are managers reliable stewards of capital, satisfying customer demand at minimal cost? Or is this a bunch of profligate rascals squandering opportunity? Each individual miner is prone to incompetence and deception, but the sector as a whole looks fairly disciplined. High liquidity and low leverage suggest that if uranium prices do in fact continue to rise - and rise relative to other commodities - miners could plow cash flows straight to shareholders. Compare private uranium miners with more indebted oil and gas counterparts whose average debt-equity ratio is 1.41. Debt intolerance may relax if expansion warrants it and miners don’t overproduce.

That best possible world is hard to imagine, given the combination of scale-obsessed nationals and ultra competitive private sector miners. The main source of private capital for expansion (M&A) may yet avoid a race to the bottom while still delivering savings to users. In any event, the tragic coordination problem of producing “too much” is a comedy to consumers, who enjoy cheap abundant supplies.

Conclusion

Are uranium companies maximizing shareholder value? “...in spite of their natural selfishness and rapacity… they divide with the poor the produce of all their improvements. They are led by an invisible hand to make nearly the same distribution of the necessities of life, which would have been made, had the earth been divided into equal portions among all its inhabitants, and thus without intending it, without knowing it, advance the interest of the society, and afford means to the multiplication of the species.” Shareholders could do much worse.

Matthew L. Kelly ([email protected]) is a student of finance at the University of Texas at Dallas, an Adam Smith Fellow with the Mercatus Center and a research fellow with the Complexity Economics Workshop. Previously, Matt was a public policy analyst at the DeVoe Moore Center. He is NOT an expert on the business of uranium mining or nuclear energy, but likes to stare at financial statements in his spare time.