Australia | Apr 04 2007
By Greg Peel
Before management at Energy Resources of Australia (ERA) was able to provide a meaningful assessment of the damage done and delay that would be caused by excessive rainfall associated with Cyclone George, the FNArena database showed a 3/2/0 B/H/S ratio from those analysts covering the stock independently of majority shareholder Rio Tinto (RIO).
Analysts have been somewhat uncertain just what to think of ERA in recent months. The stock has run very hard for two years and upside was beginning to look limited, but the surging uranium spot price, influenced to a great extent by production delays at Cameco’s Cigar Lake, could not be ignored.
This has led to upgrades, then downgrades, then upgrades again, but this time there is a bit more conviction apparent in the latest moves.
This morning UBS downgraded ERA from Buy to Neutral, and Deutsche Bank shifted from Hold to Sell, leaving the B/H/S ratio at 2/2/1. The reason for the downgrades was the announcement by management that as a result of the rain, FY07 production and sales would only be equivalent to FY06, and that FY08 production and sales would be lower than anticipated by some 25-30%.
JP Morgan, to date holding the highest price target at $31.00, elected yesterday to maintain its Overweight rating despite reducing its earnings forecasts along with guidance. The reason is that the analysts’ NPV adjustment only amounted to 2%. This seemingly trivial reduction comes about as a result of JPM’s long term uranium price forecast of US$70/lb, which is substantially higher than any other broker in the FNArena database. The analysts also apply this price all the way out to 2035, when one presumes the analysts in question would be hoping to be somewhere on a golf course, or perhaps dribbling in a corner.
Within that time frame JPM has made allowance for ERA’s massive Jabiluka deposit to be up and producing. With such an extensive NPV valuation period assessed, any short term changes will have little impact. However, the analysts had already flagged last week that they could not really see anymore substantial upside to ERA’s share price even if the uranium price did continue to climb. Upside, sure, but nothing like what we’ve seen in the past 12 months.
GSJB Were initiated coverage on ERA just last month, with the analysts suggesting:
“Our recommendation on the stock is neutral in the short term given the positive outlook on price and forecast earnings momentum. In the longer term we would sell; while we like the story and position of ERA, we struggle with valuations and think there is significant uranium price exuberance factored into uranium company share prices – as such we would regard ERA as a trading stock with little valuation support over the longer term.”
The initiation came after ERA had declared a force majeure on its sales contracts due to the cyclonic rains. Only now has the company provided a meaningful assessment. GSJBW has retained its Marketperform/LT Sell rating. ABN Amro, the other Buy, has not reported since the force majeure announcement.
If analysts were beginning to get a wit wobbly on further upside for ERA, this production downgrade has made the decision a bit easier. However, any earnings downgrade has a natural shock absorber.
As ERA is the third largest producer of uranium in the world, a 30% reduction in FY08 production should have a material effect on the uranium spot price. Pundits have been anticipating a breach of US$100/lb, and will probably get it next week. As ERA’s long term contracts are slowly beginning to rollover, the company will be in a position to negotiate higher prices. Hence there is some comfort in the production loss, but not quite enough.