Citi Initiates With Buy On ERA & Paladin

This story features ENERGY RESOURCES OF AUSTRALIA LIMITED, and other companies. For more info SHARE ANALYSIS: ERA

By Chris Shaw

Following a review on the sector Citi has taken a bullish outlook on uranium given the increase in global nuclear power capacity and green house gas emission concerns, the broker initiating coverage on both Energy Resources of Australia ((ERA)) and Paladin ((PDN)) with Buy ratings.

For the industry as a whole the broker suggests the increased capacity can mean only an increase in demand for uranium going forward, which should prove supportive for prices. When constrained supply, depleted inventory levels and fund buying is added to the mix the picture being painted seems to be one of higher prices in coming years.

As a result Citi expects uranium prices to again push through the US$100 per pound level this year and in 2009, after having run as high as US$138 per pound in 2007 before sliding back to well below the US$100 per pound level.

Both the major Australian uranium producing stocks are seen as well placed to benefit from this strengthening in prices as production is set to increase for both companies, ERA to an expected 6,000 tonnes this year from a rain-affected 5,400 tonnes last year and Paladin as Langer Heinrich gears up to full production levels.

Additionally in Paladin’s case there is a second mine, Kayelekera, due to commence production in 2009, along with a number of advanced projects in Australia where production remains possible assuming current government restrictions on uranium mining are amended.

A positive factor for both companies is decent leverage to the uranium price, in the case of ERA as existing contracts expire and are renegotiated at prices closer to current spot levels rather than at an average of about US$20 per pound as has been the case.

Paladin benefits from having few legacy contracts, meaning it already is well placed to benefit from stronger spot prices at the same time as it boosts output, Citi expecting 2009 production for the company to be in the order of 1,700 tonnes against an expected 1,180 tonnes this year.

This flows through into a solid earnings growth outlook for both companies, the broker forecasting EPS (earnings per share) for ERA to increase from the 22.9c recorded in 2006 to 42c for the 2007 year, 67.2c in 2008 and 152.3c in 2009.

With the company having little debt and with cash flows strengthening the broker sees scope for shareholders to be rewarded via increased returns, with capital management a possibility given dividends are expected to remain modest.

For Paladin the broker is forecasting EPS in US dollar terms of 6c per share in 2008 and 22c in 2009, which compares with a loss of 7.6c per share in 2006. With the development of Kayelekera continuing little is expected in the way of dividends over the next couple of years.

Apart from stronger spot prices there is some valuation upside in both stocks from exploration success in the broker’s view, as in the case of ERA it points out while mining at Ranger is currently expected to continue until 2012 this is likely to be extended to at least 2016 and maybe through 2020 if an underground mine is approved or further reserves are proved up. The Jabiluka asset also offers some upside for the company in coming years.

Paladin offers a similar story as the Langer Heinrich operation has a current mine life of around 10 years but there remains significant exploration potential in surrounding areas, while recent acquisitions by the company suggest it remains in expansion mode. The broker also points out the stock is a possible target within the sector given further consolidation among uranium players globally can be expected in coming years.

In terms of relative pricing ERA appears the cheaper of the two at present given its legacy contracts, while the broker’s valuations for the two stocks stand at $19.60 for ERA and $5.90 for Paladin.

Using this as a base the broker has set price targets of $26.00 and $7.70 respectively on the two companies, while the FNArena database shows average price targets of $23.66 and $7.80.

Citi’s coverage of the sector comes at a time of increased interest in the sector as ERA has recently been upgraded to Buy from Neutral by UBS and to Accumulate from Hold by Aspect Huntley. Overall ERA is rated as Buy five times, Accumulate once and Hold twice, while Paladin scores three Buy and three Hold ratings.

Shares in both stocks are weaker this morning in line with the broader market and as at 11.40am ERA was trading down 59c at $19.91 and Paladin was down 34c at $5.05.

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