LEGMAKER (< 20)

Cameco: Legacy Contracts are a Hedge on Uranium Pricing

June 11, 2008 – Comments (0) | RELATED TICKERS: CCJ , DNN , URZ

Many investors stay away from markets involving commodities, because of their large swings up and down. Many commodity names look fairly priced at current pricing levels, but if the commodity slips, the PE ratios will move up and a sell off can happen. One of the most speculative markets, with respect to commodities is the uranium market. The commodity is not traded at the high levels that other commodities such as oil are. Taking this into consideration, it is easy to see why the pricing movements are so much greater. Eric Bolling once said on uranium pricing that only a hand full of traders trully understand the full scope of pricing with respect to uranium. Many trade uranium, not on the supply and demand side, but with respect to oil prices. As oil goes up, people flood into the uranium miners, just as they do with solar and other alternative energy sorces.

If you have watched the uranium market with stocks such as URZ, FRG, and URRE have been crushed as the spot market for uranium has decreased significantly. Looking at the 15 year chart, U3O8 had traded in the high single digits to just shy of 20 until 2004 where a sharp movement upward ended over $130 per pound. Since then the spot price has fallen to less than half that at $59 per pound. This movement would scare most traders, but there is no need.

There are a couple of integrated miners that have exposure to the uranium market but are diversified in other metals and minerals to decrease volatility. BHP and RIO are both good plays, and they are very well managed companies. Both are well positioned through 2008 on inflationary pressures going forward. The best way to play uranium, in my opinion, is through CCJ. Although CCJ has some exposure to gold, their majority of profits are gained through the uranium market. To hedge their exposure to uranium price volatility they have negotiated legacy contracts. These legacy contracts are long term contracts placed with utility companies for the sales of uranium. It not only protects Cameco from downside in pricing, it also protects the utilities from large movements upward in price. Since there has been a huge upward move in the spot price over the last five years, these contracts have not caught up to the current spot price (for more clarification, go to Cameco's web site and check the pricing of their current contracts).

Another situation is the massive funding in China to increase their exposure to nuclear power. They have been pushed by increased usage of coal, which has not only caused severe pollution, but also their supply is being pushed and they will soon become a net importer. The United States may start adding nuclear capacity, but that is not the story as they are only adding 5 reactors. The story are emerging markets and their switching to nuclear power. Of the 93 nuclear reactors planned 38 are in China and India.

Lastly, they are fairly valued. At a forward PE of 19.79, this stock is cheap with growth expectations. Some of this is based on their legacy contracts, but even UBS saw this value as they upgraded CCJ today. This year CCJ is estimated to increase earnings by 9.9% and 16.8% next year, as found on Yahoo Finance. These numbers could be easily beaten as this company has shown resiliency. Even in the wake of one bad piece of news after another, CCJ has performed quite well. During the flood of bad news, including the flooding of Cigar Lake, delays at the McArthur River mine, and their partnership in Kazakhstan seems to be unstable, they have continued to raise their dividend and increase stock buybacks.

There is a bright side to the pullback in the price of uranium, not only is the company a possible buyout candidate by the like of the larger, multifaceted miners, but also they can acquire deposits much cheaper than they could of a year ago. CCJ is a very good long term investment and we should see increasing earnings for some time to come. When many of their legacy contracts expire, I believe their will be drastic changes in the way these contracts will be settled, and even if they aren't pricing will still remain strong without the volatility you would get with URZ or DNN.