Siddharth Rajeev: Undiscovered Energy Gems Sparkle
As an investment option, uranium glows brightly for Siddharth Rajeev, vice president and head of research at Fundamental Research Corp. He also favors coal and explains why size matters when it comes to potash in this exclusive interview with The Energy Report.
The Energy Report: When you last talked with The Energy Report, you were more bullish on the uranium price than any other commodity. Since then, the price of yellowcake has gone from about $50/lb. to just under $70/lb. Is there much upward momentum left in uranium?
Siddharth Rajeev: Yes, we continue to believe in the uranium story. You're right, uranium prices have gone up significantly in the last six to eight months. But we still think there's upside potential, mainly because the fundamentals remain very strong.
There are four reasons we believe in the uranium story: 1) Nuclear energy is a dependable and clean power source; 2) There is no direct substitute for uranium in nuclear power plants; 3) On the supply side, the primary production of uranium must increase significantly from current levels to keep up with long-term demand because the current supply deficit is met by stockpiles; and 4) Most of the new projects that we see out there are of much lower grade than the majority mines operating currently. Lower grades imply higher operating costs.
Our research indicates that the operating cost of new projects in development stages could be about $55–$60/lb. This implies that uranium prices must be significantly higher than those levels in order for the new projects to be feasible.
TER: Do you think we could see another 2007 when prices reached the $130/lb. area?
SR: We believe the market overreacted in 2007. We don't expect prices to go that high, but we definitely see significant upside from the current price.
TER: Can you put that into more specific terms?
SR: We use a long-term price of US$80/lb. in our valuation models.
TER: What is the investment thesis for uranium juniors in light of that price environment?
SR: When uranium prices hit record highs a few years ago, most junior exploration companies raised a significant amount of capital. A lot of them cut down their spending to preserve cash when uranium prices collapsed. So, when uranium prices recovered, we started seeing many juniors with quality assets in a strong cash position. Those are the kind of companies we like.
TER: Can you give us a handful of uranium juniors with upside that you're currently covering?
SR: Our top three favorites in the uranium sector are Strathmore Minerals Corp. (TSX:STM; OTCQX:STHJF), Mawson Resources Ltd. (TSX:MAW; OTCPK:MWSNF; Fkft:MRY) and Fission Energy Corp. (TSX.V:FIS).
Let's start with Strathmore. The company's advanced-stage Roca Honda project in New Mexico has a measured and indicated (M&I) and inferred resource of 33–34 million pounds (Mlb.) of uranium. And STM has a strong partner—Roca Honda is held 60% by Strathmore and 40% by Sumitomo Corp. (TKY:8053; OTCPK:SSUMF) of Japan. Management expects to put the project into production in the next two to three years. The company recently completed an internal Phase 1 feasibility study on Roca Honda. This project is considered one of the largest planned underground mines in the U.S. in 30 years. We definitely think Strathmore has a lot of upside potential from this project.
The company also has several other projects with NI 43-101-compliant and historic resource estimates. It's in a strong cash position, with more than $20 million in working capital and has a solid management team. We have a BUY rating on STM with a fair value estimate of $2.26/share.
TER: You mentioned an internal feasibility study. Does that mean we won't be able to see it?
SR: We might not get to see it. Feasibility is typically done by a third party. Companies generally start with an internal study and depending on those results, hire a third-party consultant to do a formal feasibility study that can be disclosed to the public.
TER: Strathmore also has the Gas Hills project in Wyoming. What is its status?
SR: STM commenced a development-drilling program at its Gas Hills project in central Wyoming with the objective to complete an NI 43-101-compliant resource, confirm and expand known areas of mineralization and advance its permit application, which is expected to be submitted in Q211.
TER: Do you think Strathmore may thin out some of those other projects?
SR: Yes, that's highly likely. Last year, the company sold its Pine Tree-Reno Creek properties in Wyoming to Bayswater Uranium (TSX.V:BYU) for US$17.5 million (cash) and US$2.5 million (shares). In November 2010, Strathmore announced plans to sell its Juniper Ridge property in Wyoming to Crosshair Exploration & Mining Corp. (TSX:CXX). And STM has definite plans to spin out its non-core projects. We think that's the best strategy because it gives the company more time to focus on and monetize its core projects.
TER: What do you think of the combination of STM CEO David Miller and President Steven Khan, in terms of uranium juniors?
SR: We've been following the STM team for several years and the management team has a great track record.
TER: You also mentioned Fission Energy, which has projects in Saskatchewan, Quebec and Peru. What's the next step for Fission?
SR: So far, results from the Waterbury Lake project in Saskatchewan have been extremely impressive. The stock has tripled since last May, and Fission recently completed a $7.5M financing.
TER: Some of the drill results at Waterbury have hit 5%–6% uranium, which is really quite high.
SR: They are exceptionally impressive. Drilling on the J-Zone uranium discovery has continued to turn up significant intersections of high-grade uranium. The main thing we see in this project is that high-grade uranium mineralization continues to be intersected at the unconformity. That's encouraging because mineralization at many of the major deposits in the Athabasca Basin, like Cigar Lake and McArthur River, occurs at the unconformity.
TER: The last of your top-three was Mawson Resources, which has projects in Finland, Peru and Sweden.
SR: Mawson's main project is the Rompas Gold-Uranium project in Finland. The preliminary exploration program completed by Mawson returned extremely positive results on the grab and channel samples. Just to give you an idea, channel samples collected on the property during last year's field exploration program gave grades of 1,424 g/t gold and 1.3% uranium over 0.95 meters, and 191 g/t gold and 0.44% of uranium over 2.05 meters. These are tremendously high numbers. From initial results, we believe Rompas has some of the highest upside potential of any early stage project under our coverage.
TER: Mawson is trading at about $1.75 right now, a bit off some price spikes as a result of those bonanza-grade samples. What's the next step for the company? Will it be drilling soon?
SR: Mawson recently applied for a winter ground-access permit for a shallow grid-diamond drilling program.
TER: Coal is another commodity that interests you. Despite growing concerns about pollution, prices continue to climb, mostly due to increasing demand from steel plants in places like China and Korea. We've even seen some recent takeovers, including Walter Energy, Inc.'s (NYSE:WLT) proposed acquisition of Western Coal Corp. (TSX:WTN). What should our readers expect from the coal market through the rest of 2011?
SR: We've always been bullish on coal because it remains the cheapest and most-abundant fossil fuel out there, accounting for 40% of global electricity supply. Despite the move toward cleaner energy, we believe it is tough to replace coal; consequently, we do not think coal will lose its significance in the energy sector at least for the next decade or so.
TER: What's your coal price range per ton?
SR: We use $140/ton for long-term metallurgical coal—well below the current price of $175–$180/ton.
TER: What are some small-cap, under-the-radar names in coal?
SR: One of our favorite stories is Compliance Energy Corporation (TSX.V:CEC), which is developing the Raven Coal Deposit 80 km. northwest of Nanaimo, BC. It has more than 130 million tons (Mt.) of M&I and inferred semisoft met coal. Its focus is on metallurgical coal, which has a higher value than thermal coal.
The company has very strong partners in LG and ITOCHU, which indicates that it has solid access to capital. Compliance issued a very positive prefeasibility study (PFS) in October 2010. Our valuation on the stock is $2/share; the current price is $0.35. The main reason we like this stock as an investment is because cash and marketable securities alone account for $0.25–$0.30/share. This indicates that the market value of the company's project is just $0.05–$0.10/share, which is extremely low for an advanced-stage project like Raven.
TER: Do you mean $0.05 per ton?
SR: No. The current share price is $0.35. Cash and marketable securities alone account for $0.25–$0.30/share, which means the remaining share price of $0.05–$0.10 is the value that the market assigns to the project.
TER: Could some of that low valuation be due to development risk?
SR: Generally, projects in BC have high permitting risk. Despite the risks associated with the project, we believe a market value of $0.05–$0.10/share is extremely low for a project with positive PFS results and an expected mine life of at least 16 years.
TER: What about some other coal names?
SR: The next one I want to talk about is 49 North Resources Inc. (TSX.V:FNR). It's Saskatchewan's first publicly traded resource investment company, with close to $65 million in assets under management. FNR invests in early stage resource projects, including minerals, oil and gas, and its portfolio also has coal projects.
One of its top-five holdings is a coal company called Westcore Energy Ltd. (TSX.V:WTR), which is a junior explorer focused on coal in Saskatchewan and Manitoba, where it has interest in over 95,000 hectares of land. Westcore's Black Diamond property has had four discoveries recently. FNR owns 30% of WTR's outstanding shares. The winter drilling program that commenced in January has thus far shown encouraging results.
TER: Another major commodity in Saskatchewan is potash, which is mostly used in fertilizer and prices show no signs of retreating any time soon. Why is potash so hot right now?
SR: Obviously, with high demand for food comes high demand for fertilizers. In addition to demand, the supply side of potash is very important to look at when forecasting potash prices. Most potash deposits are highly capital intensive and need billions of dollars to be put into production. As a result, new potash supply is hard to come by. Increasing demand and the bottleneck on the supply side are the primary reasons why we like potash.
TER: Last year, BHP Billiton Ltd. (NYSE:BHP; OTCPK:BHPLF) made a bid for PotashCorp (TSX:POT; NYSE:POT) in an effort to get a stable potash supply in an increasing price environment. Potash One Inc. (TSX:KCL) was acquired by the German company, K+S Aktiengesellschaft (Fkft:SDFG.F). In the last year, some potash juniors shot up as a result of this renewed interest. What are some names you cover?
SR: Our favorite potash story is a company called Western Potash Corp. (TSX.V:WPX), based here in Vancouver. Its main project is the Milestone Project in Saskatchewan, 30 km. from Regina. The company's exploring the potential of hosting a solution potash mine. Solution mines are significantly cheaper to develop and have lower operating costs than underground potash mines. Western Potash has a pretty advanced-stage project that turned up a positive scoping study in the second half of 2010 that suggested WPX can produce potash for at least 40 years at a rate of 2.5 Mt./year. That's a good source of supply for any major company or country looking for a stable source of potash.
As potash projects are capital intensive, the exit strategy of most potash juniors is either to joint venture (JV) or get acquired by a major (with access to capital). The acquisitions you mentioned, made in the last year, were mainly companies with producing or advanced-stage projects. Potash juniors typically tend to be acquired when they reach the point that the economics of their projects are known. We think Western Potash is an ideal acquisition target, particularly because it is Canada's most advanced-stage junior that has yet to be acquired.
TER: Do you have some parting thoughts on the energy markets or on the markets for energy-related commodities?
SR: We continue to have a positive outlook on uranium. We believe there are lots of opportunities in the sector—companies with quality assets and a good cash position. We are also bullish on potash. However, investors should be extra cautious when it comes to investing in very early stage potash juniors as companies have to delineate large resource estimates to cover the huge capital cost and make their projects economically feasible. Companies with advanced-stage projects and known economics have significantly lower risk.
TER: Does that wisdom stand for uranium and coal projects alike?
SR: It is more relevant for potash projects. Uranium projects are capital intensive but not nearly as much as potash projects. Coal projects are less capital intensive compared to both uranium and potash.
TER: That's good to know, Sid. Thank you for your time.
Siddharth Rajeev joined Fundamental Research Corp. in April 2006. At FRC, he oversees the research department and also covers a broad array of companies, primarily in the energy, mining and technology sectors. Prior to FRC, Siddarth had a mix of engineering and finance experience, including corporate finance experience, at a leading investment bank in Kuwait. Sid has ranked as a four-star analyst in the energy and mining sectors by Deutsche Asset Management, a division of Deutsche Bank. Sid holds a bachelor of technology degree in electronics engineering from Cochin University of Science & Technology and an MBA in finance from The University of British Columbia. He is a CFA Charterholder and has completed studies in exploration and prospecting at the British Columbia Institute of Technology. Sid is sought by the media for commentary on the valuation of small-cap stocks and industries he covers and is a speaker at various investment conferences.
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1) Brian Sylvester of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report or The Gold Report: Strathmore, Mawson, Fission and 49 North Resources.
3) Siddharth Rajeev: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None. FRC provides fee-based coverage on some companies mentioned in this article.
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