Rudi's View | Sep 13 2007
This story was first published two days ago in the form of an email sent to registered FNArena readers.
By Rudi Filapek-Vandyck, editor FNArena
Experts in North America believe shares of uranium producers, explorers and developers have hit their bottom for this year, suggesting the only way is up.
This must be a familiar sound to the ears of shareholders in Australia’s two leading listed producers, Energy Resources of Australia (ERA) and Paladin Resources (PDN), as most equity brokers and advisors have kept to their story of solid industry fundamentals ever since share prices started trending south in late April this year.
Investors and securities analysts have been slow to adapt to the changing market dynamics with price targets for Paladin Resources remaining as high as $12.10 until earlier this month. Paladin’s share price dropped below $6 this week.
The release of FY07 results in combination with commodity prices updates at stockbrokerages has injected what can only be described as a healthier dose of realism into market projections for both spot uranium prices as well as future share price valuations of companies such as Paladin.
Following Paladin’s reported $38m loss for fiscal 2007 the average twelve month price target for the shares has fallen to $7.90. Three out of five experts who cover the stock in our universe have maintained their Buy rating, against one Neutral (Macquarie) and one Sell (GSJB Were). On Tuesday, Paladin shares closed at $5.81, leaving a gap of 36% with the revised average price target.
Things look slightly better for Rio Tinto (RIO) controlled Energy Resources of Australia. As a long standing producer with legacy contracts that have hampered its operational upside, recent price target revisions for ERA have been rather mild. The average twelve month target now stands at $23.92. Tuesday’s closing share price of $17.42 nevertheless suggests upside potential of more than 37%.
ERA currently enjoys one Sell, one Neutral and four Buy recommendations. One of these Buys was only received this week with Deutsche Bank analysts concluding the share price had fallen too far and thus they upgraded the stock to Buy from Hold.
Deutsche Bank’s recommendation upgrade was followed by a similar decision at RBC Capital on Tuesday with RBC resources analysts upgrading ERA to Sector Perform from Underperform while lowering their target price to $18 from $20 previously. (RBC is not part of our universe of ten local equity experts).
In case you are among the shareholders in these companies who bought their shares sometime between April and today -meaning you are likely to sit on a paper loss on your investment- you might draw some consolation from the fact that even management at Paladin didn’t see the market reversal coming.
The company revealed at the recent results presentation it had bought 250,000 pounds of yellow cake (or U3O8) on the sport market to make up for the production shortfall at its start-up Langer Heinrich project in Namibia. The purchase price was US$133 per pound, indicating Paladin bought in the spot market close to the peak at US$136-138 in June. With the spot price rapidly declining to US$90-85 per pound since then, the company could have saved itself a few million dollars. The released financial results showed the purchase to meet its contractual obligation added some $7.8m to its losses for fiscal 2007.
The same results release also taught us that part of the company’s contractual supply obligations are priced at circa US$60 per pound. Paladin has thus far sold a little less than half of its projected annual production at Langer Heinrich via forward sales contracts.
On ABN Amro’s estimates, at a share price of circa $5.80 investors are pricing the company’s uranium production at around US$60 per pound. Given the information above that would seem spot on.
ABN Amro analysts also refer to the fact that investors used to value Paladin at close to rising spot prices, however, one would probably argue, and successfully so, that those were days of an era gone by.
Shares of uranium companies in general have been hit hard throughout the global share market correction in August. And while many other stocks recovered swiftly once the initial scare from the global liquidity crunch had been overcome, many uranium related stocks are still at or near their lows for the year, just like Paladin and ERA.
It is not difficult to conclude from the above information that share prices of uranium producers in Australia may well have bottomed –or at least that further downside potential from current share prices would seem limited – the big question remains, of course, whether we will see share prices closing the gap with broker’s price targets anytime soon.
The most logical answer to this question is: not as long as the uranium spot price continues falling. Two weeks ago, I explained how the global liquidity squeeze had turned some of the speculators in the sector into forced sellers and how this had rapidly driven the spot price sharply lower (see our Special Report “Uranium – A Changing Market Place”, August 29, 2007).
Some experts believe the US Department of Energy (DOE) is also to blame for the sharp price fall in spot uranium over recent weeks. The Department put some 200 tonnes of uranium as UF6 up for auction in August and by doing so it created a temporarily over-supply in an otherwise small and tight spot market (UF6 or uranium hexafluoride requires further processing before it can be used in power stations).
To put things in perspective: the DOE UF6 offer represents circa 520,000 pounds of U3O8 equivalent with some experts estimating the total amount of U3O8 equivalent on offer in the spot market during August was less than 700,000 pounds.
The US Department will announce the results of its August auction on September 28 and many an expert is anticipating that after this date spot uranium prices will stabilise.
Investors in the sector might also want to take into account that predictions of spot U3O8 prices reaching US$200/lb and more have disappeared from securities analysts’ lexicon.
While analysts at ABN Amro suggest producers such as Paladin are best valued at uranium’s long time price indicator of US$95/lb, colleagues at Deutsche Bank recently cut their spot price forecast by 33% to US$100/lb for the final quarter of this year. This suggests that Deutsche Bank is now on the same song sheet as colleagues at Macquarie and GSJB Were who previously flagged it may not be until sometime in 2008 before spot uranium will make a noticeable come back.
Deutsche Bank’s average price forecast for 2008 now stands at US$128.75/lb. Last week Merrill Lynch left its average price forecast for 2007 at US$105/lb. The broker’s forecast for 2008 is currently US$80/lb only.
Finally, various equity strategists are of the view that the current troubled liquidity environment, in combination with investor worries about economic growth in the US, Japan and Europe has turned the Australian share market into a stock pickers’ contest. In other words: the time of indiscriminative buying and selling has passed and performances will now become dependent on specific characteristics for individual companies in a given sector.
Assuming the same principle will apply to the uranium sector, the difference in share price performance of companies with high quality projects under development, and others, should become more pronounced.
Probably best not to expect any of the uranium companies’ share prices back at the April peak anytime soon either.