The Mystery That Is ERA

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

By Greg Peel

A few years ago, few brokers bothered to cover legacy Australian uranium miner Energy Resources of Australia ((ERA)) individually. The first reason is ERA is two-thirds owned by Rio Tinto ((RIO)). The second is that uranium was a pretty dormant market up until the mid-noughties. The third is that management has never been helpful on the numbers, making earnings forecasting somewhat of a lottery. To take a word from this morning’s Macquarie report, analysts are forced to make sometimes “heroic” assumptions.

But make them they do, now that the uranium market has exploded back onto the scene in times of climate concern and high fossil fuel prices. Realistically, there are only two Australian uranium miners worth covering if one ignores a plethora of “juniors”, and the other – Paladin Energy ((PDN)) – makes all its impact in Africa while Queensland fails to reach a decision on policy. The biggest mine – Olympic Dam – is owned by BHP Billiton ((BHP)) but thus gets lost in BHP’s extensive consolidated accounts.

That leaves ERA’s Ranger mine in the Northern Territory as the only mature Aussie uranium mine of size and distinct share price. It is also the only big mine not in uranium-friendly South Australia. Ranger and Olympic Dam are legacy mines from the country’s original Three Mines Policy, with foreign-owned Beverley replacing the third and Honeymoon becoming the fourth. On Monday, environment minister and former Nuclear Disarmament Party leader Peter Garrett approved a fifth mine, being the Four Mile Mine owned by Alliance Resources ((AGS)) and Quasar Resources (unlisted).

Yesterday ERA released its quarterly production report, and it was one off the record on a production basis. Ranger produced 1481t of uranium – 22% more than last quarter and 44% more than the June quarter 2008. This beat analyst forecasts by anything from 5% to 20%. The reasons for the fabulous result included a mild wet season and the first contribution from the new laterite plant.

In the case of the former, ERA is constantly in the lap of the gods on the weather front, which is no great surprise given Ranger is located in the tropical zone. But some wet seasons are worse than others, such that 2007 saw a shocker, 2008 was pretty bad but 2009, it seems, featured mere drizzle by comparison. This meant not only could ERA recover more ore in the June quarter because it wasn’t still pumping out March quarter water, it didn’t have to deplete stockpiles in order to satisfy contract obligations. That was handy, because there’s not much left after the Biblical floods of ’07.

In the case of the latter, laterite processing is only a new concept as it involves the use of low grade ore – once stockpiled but ignored due to the prohibitive cost of uranium recovery. All that changed when the uranium price went ballistic.

Analysts have been quick to upgrade their production assumptions ahead of ERA’s interim result release at the end of this month, but have not much changed their 2009 full-year expectations given production is always weighted towards dry season recoveries. That, and the fact there was no change to previous full-year production guidance.

But that’s half the problem. ERA doesn’t provide quarterly production guidance, only six month production guidance. So analysts are in the dark. And that’s not the worst of it. What was ERA’s revenue for the quarter? Absolutely no idea.

It is a source of teeth-grinding frustration for ERA analysts charged with making a recommendation for clients on the stock when they have no idea what price the company is achieving for its uranium until the mid-year result. It is, as Deutsche Bank describes it, the “wildcard”. What price target should one set for ERA? Lord only knows. That’s when it gets “heroic”.

The spot market for uranium is a guide, but a very insufficient one. It is the nature of the global market that uranium is sold on long-term (maybe even 20-year) spasmodic delivery contracts on pre-determined prices. Even prices negotiated today may bear little resemblance to spot market prices given the trade-off against volume. When uranium reached its US$138/lb peak, contract prices were still being settled at around a less hedge fund-driven price of US$60/lb. But these deals are “over-the-counter” and not subject to specific disclosure.

And ERA has legacy long-term contracts still out there that were price-fixed a decade or more ago – back when US$15/lb was a high price. How many contracts has ERA yet to fill at low prices? No one knows! The year-end results will tell you how much uranium the company sold and at what average achieved price. All an analyst can do is work backwards in an attempt to forecast this year’s price.

Deutsche Bank, for example, is tipping US$40.40/lb. RBS says US$36.14/lb. Macquarie is going for US$39.70/lb. It will be a bit hard to shoot the analyst if they’re wrong. And then they have to make a stab at where the long term price of uranium should be, into the future. These guesses range around the US$50-60 mark.

Indeed, the Macquarie analysts have no qualms in pretty much throwing it over to the investor to make their own decision. “What are you willing to assume?” they ask. Macquarie has an Underperform on ERA because it believes the market is pricing in too much risk-free upside for the planned expansion of Ranger, ongoing exploration and the possibility of the company’s other big resource – Jabiluka – ever getting the green light. It’s in the Kakadu National Park. However, while Macquarie believes there is a positive outlook for uranium, the analysts suggest that anyone who is willing to assume more than their long term US$50/lb is free to do so, and perhaps thus find better value in the stock.

GSJB Were also has a Sell on ERA. It believes the market is already assuming too high a future uranium price on a perceived global shortage of fuel. But the analysts suggest that if nuclear power was more accepted across the globe as a green alternative, then more green lights would be given to uranium mining projects.

Uranium is not rare. In fact, it’s as abundant as copper, although usually spread about in small amounts.

JP Morgan is another to carry an Underweight on the stock, but by contrast Citi and BA-Merrill Lynch both rate the stock a Buy. Merrills does not include any value in its calculation for the Ranger Deeps expansion nor for Jabiluka, yet the former could add $5.30 to the share price, the analysts suggest.

The bottom line is ERA offers expansion and exploration potential, which is risky to value, and exposure to upside in the uranium price, which is virtually impossible to gauge. Most brokers think the stock is probably valued about right and have settled on a Hold rating. Or is that just easier?

The average target price has jumped today from $19.81 to $20.65, against a stock price around $22.50.

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