Cameco Report GOOD

Cameco Corporation

The Fund @ Sprott Equity Research

HOLD Current: $18.71 Target: <$10.00 March 26th, 2015

Spencer Clarke BCom Candidate 2017 Concentration in Finance [email protected] Sector Analyst

Reza Syed BCom Candidate 2016 Concentration in Finance [email protected]

Sector Manager

Investment Thesis

5-Year Performance

Source: Bloomberg

Long-Term Contracts Provide Stable Revenue Streams Cameco’s business segments are all operated on a long-term contract basis that is 40% fixed

and 60% variable. Utilities purchase almost all their uranium through long-term contracts,

typically 5-10 years, and meet the rest of their needs on the spot market. Long-term contracts

provide stability in times of low commodity prices, but through the variable portion still reap

benefits from price appreciation.

Strict Regulatory Restrictions Create High Barriers to Entry

Integrated Market Leader with Unique Product Offerings

Japan’s Return to Nuclear Dominance

Export and import restrictions on uranium exist around the world. Governments must mutually

authorize the trade of uranium, and many nations have restrictions on where they can import

supply from. Furthermore, nation-specific regulations on the mining and refining of uranium

and uranium derivatives makes it difficult for new competitors to enter the market. The

average lead time on a uranium mine is upwards of 10 years.

Cameco currently has 18% of world uranium production capacity, and 20% of refining capacity.

Cameco also has the largest proved reserves of high-grade uranium, on which they have a

recovery rate of 99.4%. Through their Nukem business segment, Cameco has access to the

world’s leading traders of uranium. As uranium is not traded in any meaningful quantities on

exchanges, almost all non-contract sales occur through entities of this type, and Nukem

transacts 7% of global demand.

Before the Fukishima earthquake of 2011, nuclear energy made up over 30% of Japan’s supply

stack. Shutdowns in the wake of the disaster and Japan’s lack of any significant hydrocarbon

reserves have forced them to resort to increasingly expensive imports to meet demand needs.

Energy prices in the country have increased 30% in the last half-decade, and with the yen

depreciating as part of a quantitative easing program, reactor restarts are sorely needed.

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The Fund @ Sprott | Equity Research

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Company Overview Cameco is one of the world’s largest producers of uranium and uranium concentrates.

Headquartered in Canada, Cameco produces intermediary uranium products as well as fuel

products that are used in nuclear reactors to generate fuel for electricity. The uranium

segment, the exploration & production aspect of the firm, accounts for approximate 16% of

global uranium production in 2014. This segment produces triuranium octoxide (U3O8) and

has operations across Canada and the United States, as well as a mine in Kazakhstan. The firm

is currently evaluating projects in Australia as well. Cameco is involved in several mining

projects involving underground, open-pit, and in-situ recovery mines, and has approximately

429M pounds of proven and probable mineral reserves. In addition, Cameco estimates that

there are 379M pounds of measured & indicated mineral resources and an additional 311M

pounds of inferred mineral resources that belong to the firm. The fuel services segment

supplies uranium fuel and refinement services to nuclear reactors that generate power. The

major fuel products include uranium trioxide (UO3), uranium dioxide (UO2), as well as

uranium hexafluoride (UF6). These products can be even further enriched from their natural

make-up by enhancing the presence of the fissile isotope known as uranium-235 to stimulate

the nuclear fission reaction required to generate power. Cameco is responsible for this entire

process, as well as providing fuel and reactor equipment used in heavy-water reactors,

particularly Canadian Deuterium Uranium (CANDU) nuclear reactors. In 2014, Cameco

controlled about 20% of the world’s UF6 conversion capacity. The third business segment

belonging to Cameco is known as NUKEM. NUKEM was acquired by Cameco in January 2013

and is an entity that specializes in trading uranium, uranium concentrates, and uranium-

related products. Cameco utilizes NUKEM to optimize their positions taken during the physical

trading of uranium concentrates on open markets. In addition, NUKEM is used to negotiate

prices for uranium conversion and uranium enrichment services. NUKEM also recovers

natural and enriched uranium from facilities in western North America. In addition, Cameco

has a 24% interest in Global Laser Enrichment, and initiative that uses lasers to enrich

uranium with uranium-235. Because Cameco has operational control of uranium production

and enrichment facilities, this venture offers a synergy that will allow the firm to enhance

profit margins. The laser method would reduce costs incurred during the uranium enrichment

process.

Cameco had a 31.6% stake in the Bruce Power Limited Partnership, however it was sold to

BPC Generation Infrastructure for $450M. The Bruce Power Limited Partnership is a

partnership of eight electricity generation units that provides 6 300 MW of power to Ontario

grids. The partnership accounts for 25% of daily electricity consumption within Ontario.

Cameco is involved in operations that span the entire nuclear fuel cycle, spanning from

exploration, to refinement, enrichment, and manufacturing.

Figure 1: Revenue by Product Segment Figure 2: Revenue by Geographic Region

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Sector Outlook The basic materials sector has been subject to a large downturn as a global crude oil, natural

gas, and base metal supply glut persists and brings the risk of economic contraction to many

countries across the globe. The falling price of crude oil has brought on slashed global GDP

expectations and brought an onslaught of various rate cuts and central bank easing measures

in 2015. In addition, what has started out as a global iron ore supply glut has transformed into

a relentless selling-spree of iron ore on public markets as weak Chinese macroeconomic data

significantly weakens demand expectations for the metal. Iron ore with 62% ferrous content

delivered to Qingdao, China, is testing 6-year lows as it trades at US$55.46/metric ton on

public markets. The situation does not look too differently on the home-front here in Canada.

On March 16, Western Canada Select, the heavy sour crude oil that is produced and blended in

Alberta, dropped below US$30/barrel and reached a low of US$28.54/barrel on March 18. Due

to recent developments in Yemen, a nation responsible for about 0.1% of global oil production

according to EIA estimates, the price of Western Canada Select has since rallied to over

US$38/barrel, however Canada is still expected to have to go further easing measures after a

surprise overnight rate cut occurred on January 21. Due to low oil prices, the Bank of Canada

weighs in on deflationary fears that are especially evident in Alberta. After cutting its

overnight rate by 25 basis points to 0.75%, the Bank of Canada is expected to have to make

another rate cut due to weak output from low crude oil and lumber prices.

Figure 3: Iron Ore

Source: Bloomberg

The Bloomberg Commodity Index fell to its lowest level since June 2002 on March 26, reaching a level of 101.0461.

The index represents the movements and price fluctuations in various commodities. The index consists of 22

constituents that each have a floating percentage weight in the index. While crude oil and iron ore have contributed to

the falling of the index, other base metals such as copper have also considerably fallen in price due to weak Asian

demand. We feel that at this point in time, the production surplus is approaching a maximum as continuously lower

prices test production costs for various projects across the globe and will contribute to the inevitable shutdown or

temporary halts in exploration and production operations. As suppliers begin to halt production projects, we believe

that production can only to continue so much before finally falling. Several countries have already implemented caps

on production of base metals such as iron ore and lower prices will continue to weed out inefficient producers. For

example, oil production will be tested in April as rig counts fall to a considerably low level. In the medium-term, we

will need to see if production can continue to with-stand its historically high pace even past the projected April

decrease and into the summer. Ultimately, this will be the true test for commodities and the outlook on commodity

prices.

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Figure 4: Western Canada Select

Source: Bloomberg

Figure 5: Yemen Crude Oil Production

Source: Bloomberg

The North Dakota total rig count fell below 100 to 98 rigs on March 20. This is the lowest level in rigs since April 2010,

and is nearly a 50% drop from the September 2014 count of 189. However, the drop in rig count has appeared to do

little to production levels, as production from the Bakken region continues to remain at all-time highs. The EIA has

forecasted that production in this region will fall by 80K b/d for its next Drilling Productivity Report. However, about

1.32M b/d are still expected to be produced from the Bakken region for the month of April, which is still very close to

the all-time high level achieved in March of 1.328M b/d. Production will be a key indicator for the price of oil,

particularly WTI crude oil. In addition, U.S. crude oil production continues to experience all-time highs as per

Department of Energy statistics, however this is also expected to begin to decline in April as 3 major oil producing

regions in the USA are projected to finally experience a decline in production for the April Drilling Productivity Report.

For the time being, however, there appears to be no signs of slowing down. Inventories have reached their highest

recorded levels in the USA, the EIA reports that this is the highest level of crude in storage in at least 80 years. Currently,

there are approximately 466.68M barrels of crude in storage in the United States.


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Figure 6: Canadian Overnight Rate

Source: Bloomberg

Figure 7: Lumber

Source: Bloomberg

While the basic materials sector has been slumping due to a major supply glut, the considerable fall in the sector raises

global uncertainty in regards to the macroeconomic outlook for the global financial environment. Reduced Asian

demand, slashed GDP expectations, over 25 central bank rate cuts in 2015 thus far, and a €1.1T+ asset re-purchasing

program being undertaken by the European Central Bank does not bode well for the macroeconomic environment. If

monetary easing measures do have success in stimulating money creation and interbank lending in each country’s

respective domain, perhaps the demand for basic materials will be stimulated and an upside in commodities will be

present. However, until these issues are sorted out, any rise in price will be due to a decrease in supply rather than an

increase in demand. In other words, we do not expect the supply/demand balance to reach an equilibrium because of

significantly increased demand, but rather due to a fall in the unsustainable levels of output that exists in commodities

today.


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Figure 8: Bloomberg Commodity Index

Source: Bloomberg

Figure 9: Commodity Index Member Weightings

Source: Bloomberg


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Figure 10: North Dakota Rig Count

Source: Bloomberg

Figure 11: Bakken Production

Source: Bloomberg


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Figure 12: Total U.S. Crude Production

Source: Bloomberg

Figure 13: Total U.S. Crude Inventories

Source: Bloomberg


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Figure 14: ECB Total Assets

Source: Bloomberg

Figure 15: Federal Reserve Total Assets

Source: Bloomberg

We elected to conduct research on Cameco because we felt that exposure to a unique commodity such as uranium had

potential to be profitable and relatively uncorrelated with general market activities. Japan was once one of the largest

producers of nuclear power in the world before the Fukushima disaster in 2011, involving the Fukushima-Daiichi plant

being hit by a tsunami that was triggered by an offshore earthquake. In response, the Japanese government closed all

operating nuclear reactors in the country. Since that time, the demand for uranium has decreased significantly.

However, as the Bank of Japan undergoes an aggressive quantitative easing program after experiencing years of zero-

inflation and deflation, and considering that Asian LNG buyers pay enormous premiums in comparison to American

buyers because of lack of midstream infrastructure, a devaluing Yen against the dollar, and significant liquefaction costs,

we felt that it was a great opportunity to explore nuclear power and the uranium market. Our thesis relies on the

restarting of Japanese nuclear reactors, which has already started to begin as 2 reactors have already received

permission from the federal government to restart, however their restarts have been delayed due to the need for safety

standard upgrades.


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Figure 16: BOJ Total Assets

Source: Bloomberg

Figure 17: Asian LNG Price Premiums

Source: IEA


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Figure 18: USD/JPY

Source: Bloomberg

Industry Dynamics Essentially, the demand for U3O8 and other uranium products have decreased significantly as

Japan shut down all of their reactors. However, the Japanese government does appear to be

beginning to allow reactors to come back online, but this process is being continuously

delayed to due heavy government regulation and public fear of nuclear power generation

since the 2011 Fukushima-Daiichi disaster.

The current spot price of U3O8 is significantly lower than its 2011 highs due to the closing of

all nuclear reactors in Japan, taking a significant amount of demand away from the uranium

market. We expect that as Japanese reactors come back online that demand will be stimulated

and the price of U3O8 will begin to rise, however because of a sluggish start to reactor restarts,

the price does not yet reflect expectations of increased Japanese demand. The demand for

U3O8 is directly linked to the level of electricity generated by nuclear power plants. We

believe that U.S. nuclear electric power generation will remain relatively stagnant, leaving

much reliance on Japanese reactor restarts. Essentially, the more reactors that come back

online, the more that growth in uranium demand will be experienced. On a positive note, the

EIA projects that approximately 1 122 MW of nuclear electricity generation capacity will be

brought to the U.S. market in 2015 through the Tennessee Valley Authority’s Watts Bar 2

nuclear facility. The facility is listed as coming online in December 2015 and will be the first

reactor brought online in the USA in nearly 20 years. The EIA also projects that there will be a

large number of coal capacity retirements due to new standards set out by the EPA through

the Mercury and Air Toxics Standards (MATS). These standards require large coal-fired and oil

-fired electric generators to meet considerably stricter emissions standards. Because of this,

many operators have decided that retiring these units would be a cheaper alternative than

attempting to comply with these new emissions standards.

In addition, the EIA notes in their Q4 2014 Uranium Production Report that U.S. uranium

production represents about 11% of the 2014 uranium market requirements of 46.5M pounds

for generating electricity. Uranium concentrate production has been consistently increasing

year-over-year, boding well for the increased demand case for raw uranium products such as

U3O8.


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Figure 19: U3O8 Spot Price

Source: Bloomberg

Figure 20: U.S. Nuclear Power Generation

Source: EIA


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Figure 21: 2015 Electricity Generation Capacity

Source: EIA

Figure 22: U.S. U3O8 Production

Source: EIA

Similarly, in the UF6 market, a uranium concentrate that is produced by Cameco and used to fuel nuclear reactors,

demand is considerably weaker than in 2011 and prices are lower to reflect this weak demand. Demand for UF6 is based

off of electricity generated by light-water nuclear power plants. The EIA projects that the demand for nuclear energy at

both light-water reactors and heavy-water reactors will increase into 2020 for the USA. Heavy-water reactors are

typically fueled by UO2, so the demand for UO2 will be affected during times of increase heavy-water electricity

generation rather than the demand for UF6.


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Figure 23: UF6 Spot Price

Source: Bloomberg

Figure 24: Low-Enriched Nuclear Fuel Demand

Source: EIA


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Figure 25: High-Enriched Nuclear Fuel Demand

Source: EIA

However, there are other positive indications that demand for uranium will pick up. The

Nuclear Regulatory Authority (NRA) in Japan has been implementing an active process for

restarting reactors where 11 restart application have been submitted that cover 21 reactors

for 11 separate utility facilities. The frontrunners are the two Sendai reactors which are set to

restart in the first half of 2015. In addition, two Takahama reactors were granted preliminary-

round safety approval from the NRA in late 2014 and are in the final regulatory stage of the

process for being granted permission to restart. Japanese utilities are spending billions of

dollars on plant upgrades in anticipation of a more aggressive environment for reactor

restarts from the government. In addition, China is also undergoing a large nuclear growth

program as LNG imports become considerably expensive for the nation that is currently

experiencing slowed growth and slowed inflation. In 2015, China was forced to cut their key

one-year lending rate by 25 basis points to 5.35% and their key one-year deposit rate by 25

basis points to 2.50%.

Figure 26: China Key One-Year Lending Rate Figure 27: China Key One-Year Deposit Rate


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Figure 28: Global LNG Imports

Source: IEA

Figure 29: Forecasted LNG Demand Growth

Source: IEA

We believe that this is an excellent opportunity for China to invest in nuclear power. Considering that there is waning

European demand for LNG and the disappearance of North America as an importer of LNG due to the shale gas boom, a

lot of natural gas demand in the future is expected to come from Asia. However, with the significant premiums that

Asian buyers must pay for LNG, we feel that this may not be sustainable for countries such as China and Japan. Due to

how expensive natural gas is in Asia, it is questionable whether gas is an efficient channel of energy production.

However, Asian markets are expected to make up a majority of future LNG imports because of the giant increase in

anticipated demand and current demand. The IEA forecasts that non-OECD Asian countries will import nearly 150B

cubic metres of gas in 2019. In addition, Japan is currently the world’s largest importer of LNG. China is anticipated to

surpass South Korea as the world’s second-largest LNG importer as Chinese demand will increase and as the South

Korean government pushes for nuclear programs to start up in the country as an alternative and cheaper way of

producing electricity.


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Figure 30: Price-Indexation for LNG Imports

Source: IEA

China’s total private and public debt have increased to more than twice its GDP since 2007. No

other developing country has accumulated debt this quickly according to McKinsey Global

Institute. The Chinese economy is growing at its slowest pace since 1990. However, because of

expected increased demand for LNG, most Asian countries will need to import even more gas

to meet demand growth as production fails to grow at the same pace as consumption. The IEA

expects that half of the increase in global gas consumption will require additional imports.

With that, the IEA also expects Asia to account for 80% of the global LNG imports in the

medium-term.

We feel that this is a great opportunity for China to ramp up production of nuclear energy.

China is expected to account for 30% of the demand growth in natural gas in the next 5 years,

indicating the need for increased electricity generation capabilities. However, the average

Asian LNG prices are substantially greater than that of Henry Hub prices. We feel that this is

not sustainable for China and Japan as their economies battle economic downturns. An

excellent and efficient alternative for Asian energy production lies in nuclear power. Currently,

the main competitor to natural gas in Asia is coal because of how cheap it is. However, there

are negative environmental consequences associated with coal-fired power plants, and many

countries are beginning to realize this and search for greener alternatives. In addition, gas

prices are typically subsidized by government in non-OECD Asian countries. These lower

prices disincentivize domestic production, forcing countries to rely on imports even more.

These imports result in budget deficit issues for governments.

In Asia, long-term gas contracts are typically oil-indexed. This makes oil-indexed gas prices

much higher than American hub-indexed gas prices. In addition, there is a great deal of

inflexibility in the Asian LNG supply chain due to the presence of final destination clauses and

take-or-pay clauses. Oil-indexed prices fail to reflect developments in the gas market, but

Asian producers prefer oil-indexed contracts because many development costs are linked to

oil prices. A mixture of oil-indexed, Henry Hub-indexed, and Asian hub-indexed contracts are

expected to be built into contracts for the long-term.

Capital costs of more recent LNG projects have increased sharply, in fact so much that in some

areas investors are concerned about just being able to recover their initial investments in the

project. This is present in the minds of those planning to invest in the next generation of LNG

projects. We feel that for these reasons, nuclear power generation is an excellent alternative to

power that is gas-based. The IEA notes that especially as the potential for nuclear energy is

around the corner, those planning the next generation of LNG projects may very well abort

those projects and switch directly to nuclear.


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Figure 31: Energy Conversion

Source: World Nuclear Association

The World Nuclear Association (WNA) notes that generating electricity accounts for about

40% of primary energy use. Demand for nuclear energy is increasing by 2.7% according to the

WNA, which is twice as fast as total global energy demand. World uranium mine production is

at about 60 000 metric tons per year, but much of the market is supplied by secondary sources

such as uranium stockpiles from decommissioned nuclear weapons. In addition, natural, low-

enriched uranium is already by far the most efficient method of generating energy known to

mankind. This is without an enrichment process that uranium typically goes through in order

to be used in low-water reactors.

Per kilogram of natural uranium, which consists of only 0.7% of the fissile isotope uranium-

235, uranium is by far the most efficient method of generating electricity. Unenriched natural

uranium is appropriate fuel for a heavy-water reactor such as a CANDU reactor. CANDU

reactors are heavy-water reactors that use deuterium oxide as a coolant. While heavy water is

significantly more expensive than ordinary light water, it yields significantly enhanced power

generation through encouraging an environment for an increased amount of neutrons. When

this happens, more energy is given off and uranium-235 is increasingly stimulated. Through

this, uranium-235 becomes even more fissile and generates are greater amount of nuclear

fission reactions in the atoms within the reactor. The heavy-water reactor operates without

any sort of fuel-enrichment facilities, which mitigates the capital costs of heavy water.

Light-water reactors require further enrichment of natural uranium, however, because the

environment within the reactor is not supplemented with deuterium oxide and does not allow

for an appropriate amount of nuclear fission reactions. For this reason, the natural uranium

needs to undergo an enrichment process involving an increased proportion of uranium-235 to

stimulate neutron breeding. When the neutron breeding ground is desirable, the splitting of

atoms within reactors will allow for more neutrons to escape and become free neutrons. This

contributes to a greater deal of mass lost by the atom, and because of Albert Einstein’s Theory

of Relativity (E=MC^2), we can infer that the mass lost by the atom in neutrons is equivalent to

the amount of additional energy that is generated through the release of free neutrons. The

free neutrons then interact with fissile isotopes, in this case uranium-235, and produce even

more fissile reactions. These atoms split, more free neutrons are released, and further

interactions with uranium-235 occur. Nuclear power plants operate by controlling the rate of

how many nuclear reactions occur within a given time interval. This control is exercised

through the use of several safety measures. The materials in a reactor core and an appropriate

uranium enrichment level will allow for a controlled level of uranium-235 content and make

for the impossibility of a nuclear explosion, even if all safety measures fail.


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Additionally, uranium tends to react very mildly with aluminum as it forms as chemical layer

similar to a resin which resists further reactions from occurring. For this reason, reactor cores

tend to be lined with aluminum. It is important to note that in the case of Fukushima, the plant

was actually hit by a tsunami. Fukushima met all necessary safety requirements and operated

under conditions that made a spontaneous nuclear explosion impossible by proper

maintenance of uranium-235 levels and employing the correct materials within the reactor

cores of the plant.

From a production standpoint, uranium is mined one of three ways. Open pit mining is used

when uranium ore is found near the surface of the ground, typically less than 100 metres deep.

Because of the high costs associated with using an open pit mining method, it is typically not

used if the orebody is located over 100 metres below the surface of the ground. Another

method is known as underground mining, which is still a considerably expensive method of

mining uranium. Underground mining is appropriate when the orebody is very deep

underground however in order for it to be feasible, the quality of ore grades in the deposit

needs to be high in order to justify the high costs associated with underground mines.

Cameco’s McArthur River and Cigar Lake underground mining operations have deposits of ore

that are of a grade that is 100 times the world average. This allows for Cameco to be able to

utilize underground mining. A third method of mining is known as in-situ recovery, which is

used when there is a deep orebody. In-situ recovery can also be used when uranium is present

in multiple layers underneath the ground, however these layers are not adjacent to each other.

Additionally, if the grade of ore is not high enough to justify spending money on an

underground mining operation, in-situ recovery will typically be used. In-situ recover involves

recovering uranium through boreholes that are drilled into a deposit and then injected with a

solvent solution known as a lixiviant into the body of the ore formation. A typical lixiviant for

mining uranium commonly consist of water containing oxygen and carbon dioxide, or sodium

bicarbonate. The idea of in-situ recovery is that the fluid passes through the body of the ore,

reverses the exchange process of the uranium, and mobilizes it within the liquid solution. In-

situ recovery can be used in combination with hydraulic fracturing, which works to break into

the body of a rock formation through highly pressurized liquids made of sand, water, and the

lixiviant.

Figure 32: In-Situ Recovery


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Cameco is the only mining company that would allow for pure exposure to solely uranium.

Cameco has deposits in 2 of its underground mining operations that are 100 times that of the

world average, and is a major contributor to the supply of uranium. Cameco is involved in all

stages of the uranium production process, from the initial mining and extraction of uranium,

to refining it into yellowcake, and then producing fuel products out of the yellowcake through

enrichment and other chemically-altering methods. Over the next decade, Cameco expects

world uranium demand to grow at an average of 4%, totaling 2.2B pounds from 2015-2024.

Cameco estimates that in order to meet global demand over the next decade, approximately

70% of global uranium supply will come from primary production sources, while 15% will

come from existing secondary supply sources and 15% will come from new exploration

initiatives. In addition, uranium consumption has outstripped uranium production every year

since 1985. There are concerns that current inventory levels and uranium supplies will not

meet long-term demand needs with the expected restarting of Japanese nuclear reactors.

Cameco controls about 20% of the world UF6 conversion capacity and supplies UO2 for

CANDU reactors across North America. In the long-term, Cameco has commitment to supply

200M pounds of U3O8 in contracts with 43 customers worldwide. To put that in perspective,

worldwide mine production was 147M pounds of U3O8 in 2014. Cameco also has

commitments to purchase about 25M pounds of uranium products from 2015-2028 on public

markets. Cameco targets a ratio of 40% fixed-price contracts and 60% market-related

contracts. Fixed-price contracts contain prices negotiated at the time of the contract

acceptance, and then gradually raise the price year-over-year. Market-based contracts allow

for the price of each delivery to be more subject to what current spot prices on public markets

are rather than less volatile fixed estimates. The setup of contracts allows Cameco to

participate in uranium market movements, however they will have protection with fixed-term

contracts in case the price of uranium takes an undesirable turn.

For the year of 2014, Cameco had an average cash cost of US$18.66/pound of U3O8 and non-

cash costs of US$9.30/pound of U3O8, making for a total production cost of US$27.96. Cameco

produced 23.3M pounds of U3O8 in 2014 and is the world’s largest producer of U3O8. Cameco

does purchase about 25% of U3O8 on public markets through its NUKEM segment, and in

2014 experienced an average cash cost of US$38.17/pound for open-market purchases. In

total, the weighted average costs for production and purchases cost the firm about US$30.34/

pound of U3O8. In 2014, Cameco managed to achieve an average realized spot price of

US$47.53/pound of U3O8 for its uranium segment. The majority of its fuel services segment

contracts are at a fixed price per kilogram. Similarly to exploration contracts, the price

escalates over the term of the contract. In 2015, Cameco plans to produce 9-10M kg of

uranium products. Figure 33: U3O8 Supply & Demand Outlook

Source: Cameco Estimates

Competitive Positioning


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The prices of U3O8 and UF6 have fallen significantly since their peak levels in 2011. As of

recently, the price of uranium products has built up slowly and steadily as investors begin to

speculate on Japanese reactor restarts. Since Cameco is a pure exposure to uranium and

movements in the uranium price reflecting the supply/demand balance, as Japanese reactors

come back online, Cameco will benefit directly as investors begin to raise the price of uranium

products on public spot markets. Demand for uranium is expected to continue to grow as coal

becomes more heavily regulated and LNG imports become unfeasible for Asian net-importing

countries that pay significant premiums in comparison to Henry Hub prices.

Cameco has large array of contract commitments which are guaranteed sales for the firm. In

addition, Cameco has a strong balance sheet, a large amount of uranium in proven & probable

reserves, and strong cash flows. Cameco is able to produce at low costs and realize an average

price of $US47.53/pound of U3O8 while public spot markets have kept U3O8 at approximately

$39.50/pound as of late 2014. While Cameco is focused on its North American operations,

many opportunities could arise for international exploration if Japan elects to restart their

reactors in a quick manner. The restart of these reactors will stimulate demand heavily and

would increase the price of uranium substantially.

Major Risks

Although we expect that Japan will need to start its reactors in order to be able to generate

electricity in an economical fashion, the restart process has cost many companies billions of

dollars already in attempting to bring their infrastructure up to speed with the new, stricter

Japanese government regulations. This slow restart may indicate that Japan is hesitant to start

their reactors and may not stimulate uranium demand in the manner that Cameco or public

markets expect. Nuclear power plant infrastructure is very costly and advanced and the slow

restart process is evidence that restarting nuclear reactors is no simple task.

Additionally, Cameco is currently involved in a large dispute with the CRA. The CRA seeks

$1.5B from Cameco in a transfer pricing dispute. This involves Cameco’s European subsidiary

based out of Switzerland. Essentially, Cameco would allocate funds to the European subsidiary

in order to avoid higher Canadian taxes. The CRA mandates that during all dispute cases, the

firm in question needs to provide 50% of the taxes that are being sought after. This means that

Cameco will need to pay the CRA about $750M regardless of whether any wrongdoing

occurred or not. If Cameco wins this case, they will get be able to reacquire their funds,

however this is still an enormous portion of the company’s cash, and then some. Cameco

expects to have to issue credit notes in order to fund this dispute. If Cameco is found guilty of

these charges, the $1.5B charges set out by the CRA will be equivalent to about 2 years of

operating income for the firm. This would significantly impact Cameco in a negative manner.

Growth & Risk Analysis


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Income Statement

Revenue forecasts are based off of Cameco’s average realized spot price of US$47.52/pound of

U3O8 and Cameco’s contractual commitments to supply 200M pounds of uranium of U3O8 in

the long-term. The production figure was divided equally amongst the 6 forecasted time

periods and assumes that Cameco will produce at approximately this rate into perpetuity

without any production additions. The average spot price for U3O8 is US$35.50/pound for

2014, while the current price for long-term uranium contract 20 months out is $42.82/pound,

about 20% higher than the average 2014 spot price. This represents an estimated annual

increase of about 12.4% in the price of uranium. The forecasts, however, have the price of

uranium increasing by 10% each year.

Figure 34: Income Statement Forecast

Balance Sheet

Cameco is currently relatively underlevered, however we anticipate that Cameco will need to

issue a considerable amount of debt in order to fund the CRA dispute. Cameco’s senior

unsecured notes are rated BBB+ by S&P, however their outlook is negative due to the CRA

dispute and the amount of debt that will be required to fund the litigation process and the

charges at hand. This presents a concern that the company will not be able to produce

anywhere near enough to simultaneously provide stable cash flows, be profitable, and fund the

CRA dispute. Management has no clear guidance on future plans for debt obligation, which is

an additional concern in itself.

Financial Statement Analysis

Source: Student Estimates

Figure 35: Balance Sheet Forecast


2012 2013 2014 2015E 2016E 2017E 2018E 2019E CV

Current Assets 1,910 1,716 2,068 3,108 3,851 5,010 6,076 7,237 8,237

Current Liabilities 40 40 40 9 11 15 20 13 17

Pension Liabilities 0 0 0 0 0 0 0 0 0

Long-Term Debt 0 0 0 0 0 0 0 0 0

Total Equity 169 186 197 185 188 198 202 202 200


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Cash Flow Statement

Cash from operations will increase due to revenue growth that will drive net income growth and expand operating margins. The increase in net income is expected due to Cameco’s strong contract setup and the forecasted increase in the price of uranium as the potential for Japanese reactor restarts inches closer. Cash from investing is largely affected by capital expenditures, which management expects to have to make significant cuts to in 2015 and beyond. Capital expenditures will be cut by about one-third of 2014 levels due to a combination of the CRA dispute and falling uranium prices since 2011. We also expect capital expenditures to have to remain significantly lower than previous levels. Cash from financing will largely come from debt being used to fund the CRA dispute. Cameco’s

first major round of maturities occurs in 2019, so it will be on the hook for interest and

principal repayments for the long term. In addition, more debt obligation had to be issued

because of the recent CRA dispute. This reflects the negative outlook assessed to Cameco by

S&P.

Figure 36: Cash Flow Forecast


Valuation Discounted Cash Flow

We were limited in the type of valuation that we could use because Cameco is not purely an

exploration and production play, so using an NAV model to forecast out revenues was not

optimal. In an attempt to capture the most robust forecasts more Cameco, we used a DCF

valuation. A target of approximately $12.50 was reached, indicating that Cameco is

significantly overvalued. The DCF uses a CV growth rate of 3%, a WACC of 13.2% which

includes 12.7% cost of equity and 0.5% cost of debt, and may not properly capture all of the

debt required in order to fund the CRA dispute. This is because management provides very

little guidance on this subject and it is likely that management will have to release even more

debt in order to pay off these charges outlined by the CRA.

Figure 37: DCF Calculation


Page 24

Disclaimer This report was written by a student currently enrolled in a program at the Sprott School of Business. The purpose of this report is to demonstrate the investment analysis skills of Sprott students. The analyst is not a registered investment advisor, broker or an officially licensed financial profes-sional. The investment opinion contained in this report does not represent an offer or solicitation to buy or sell any securities. This report is written solely for the consideration of this student managed investment fund and should not be used by individuals to make personal investment decisions. Unless otherwise noted, facts and figures included in this report are from publicly available sources. We cannot guarantee that the information in this report is 100 percent accurate, although we believe it to be from reliable sources. Information contained in this report is only believed to be accurate as of the day it was published, and it is subject to change without notice. It cannot be guaranteed that the faculty or students do not have an investment position in the securities mentioned in this report.

DO NOT BUY

Investment Positives

We feel that Cameco is in an industry full of opportunities as nuclear power can assist many

countries in providing a much cheaper and more efficient channel of producing and generating

electricity and power. With the reactor restarts in Japan on the near-term horizon, the demand

for uranium is expected to grow as reactors purchase uranium materials from public markets.

This bodes well for the expected future price of uranium.

Cameco has strong assets and is a large contributor to the uranium production market. We feel

that Cameco has a considerable grip on the industry due to its size and experience in the

uranium production and refinement services markets. Cameco is a completely integrated

uranium firm that encapsulates all aspects of the supply chain management production line.

Cameco would provide us with pure exposure to uranium, more than any other firm possibly

could.

Cameco’s ability to negotiate long-term contracts with committed buyers has inevitably saved

them from a much worse fate.

Investment Negatives

The significant decline in price of uranium after the Fukushima disaster has significantly

affected the business model of Cameco. In addition to contributing to lower revenues for all

segments of the firm, nuclear power plant infrastructure is becoming increasingly expensive

as governments weigh in on upgraded safety standards and emissions criteria.

The Japanese reactors have been sluggish to start, so demand for uranium has not been

stimulated yet. In addition, a large dispute with the CRA poses a threat to wipe out the entire

business. If Cameco loses the case against the CRA and is forced to pay $1.5B due to a transfer

pricing dispute, we could very well see Cameco be forced to close its doors and cease

operations.

Investment Recommendation

Documents

Cameco Report GOOD