Negative energy

PORTFOLIO POINT: Uranium miner Paladin is still worth more than $1 billion, even after seven years of losses. At current ore prices, some are wondering if the stock will lose more energy.

Miracles rarely occur on the stockmarket, but the fact that the uranium miner Paladin Energy is still valued at more than $1 billion after seven consecutive years of losses, and a sharply lower price for the only commodity it sells, has a miraculous feel to it.

In fact, the full Paladin story dating back several decades also qualifies for the tag of miracle because of the way the company survived a period as a genuine “penny dreadful”, trading at less than 1 cent, while clinging to the hope that uranium would make a return as a high-priced fuel.

Uranium did, for a while, reaching a high of US$135 a pound. But that was before Japan’s Fukushima nuclear accident sent uranium back to the doghouse, with its short-term price dipping below US$50 a pound. This made it hard for Paladin (or many other uranium producers) to break even, let along post a profit.

Confirmation of the difficulties confronting Paladin were contained in the latest annual result released last month, which included a loss after asset-value write-offs of $172.8 million, roughly double the 2011 loss of $82.3 million.

Losing more money, while selling more uranium (revenue rose from $268.9 million to $367.4 million) is a poor look, though it is one that should be less of a surprise to regular readers of Eureka Report than most investors.

As far back as April last year I was hanging a red (sell) tag on Paladin because of its poor track record in delivering on management promises.

Back then it was pointed out that Paladin was battling “stiff headwinds, increasing production just in time to be hit by falling uranium prices” – precisely the same problem today confronting iron ore miner Fortescue Metals.

Significantly, on the day that original Paladin story was published the stock was trading at $3.64 and capitalised at $2.8 billion.

Today Paladin is trading around $1.24 and capitalised at $1 billion, but given the seven-year loss record, that includes a whopping $480.2 million in 2009, it is reasonable to ask whether it remains overvalued, or whether it is a stock that will deliver a miracle recovery, replicating its original phoenix-like rise from the ashes of a decade ago.

Back in 2003 interest in Paladin was kindled by a rise in the uranium price, with the stock “soaring” from around half-a-cent to 3c in the middle of that year as investors recognised the unique position of the company as the owner of undeveloped uranium assets in Australia and Africa.

International demand for freshly-mined uranium had started to recover after years of depression caused by a flood of reprocessed weapons-grade material flowing out of the former Soviet Union, and from the US as it de-commissioned warheads.

From being a commodity nobody wanted in the wake of the Three Mile Island nuclear meltdown (1979) and Chernobyl (1986), uranium became the fuel of the month during an era of rising oil (and coal) prices, and widespread debate of an almost forgotten phenomena called “peak oil”.

By mid-2008, as the oil price soared, Paladin shares reciprocated, passing the $12 mark, and making multi-millionaires of the management team led by chief executive, John Borshoff. He had survived the equivalent of a nuclear winter, driving a clapped out company car and working from a dowdy office in a back street of the inner-Perth suburb of Subiaco.

But, in hindsight, 2008 was the year when Paladin’s luck started to run out. The global financial crisis hit. Oil crashed, as did uranium. It was also the year that a handful of small US natural gas producers started to report huge flows of gas from beds of shale rock long-regarded as impervious and uneconomic.

Peak oil is yesterday’s topic, replaced by gas glut. Uranium’s appeal as a low-polluting fuel has been replaced by a belief that gas, while still a fossil fuel that has to be burned and generates carbon dioxide in the process, causes half the pollution of coal. As such, it is seen as acceptable, albeit not perfect.

Paladin’s problem, which has been simmering away for several years, and which management persistently talks down, is that it is not a low-cost producer of uranium. It may have reached the stage where its assets would perform better if part of a bigger, specialist uranium producer.

Analysts at Commbank told clients earlier this week that Paladin’s costs are “stubbornly high”, while uranium prices are flat. The view was complemented by a recommendation suggesting that the stock was a sell, echoing advice Goldman Sachs had been dispensing for more than a year.

Other brokers are more optimistic. UBS has a neutral rating on Paladin, Deutsche Bank a hold, and Merrill Lynch and RBC a buy tip.

Divided as the brokers are, the problem for me with Paladin is that it is persisting with promises that better times lie ahead, and that the wider world (especially the media) is too negative when reporting the uranium story and ignoring the long-promised boom in construction of nuclear power plants – a view which neatly sidesteps the ready availability of uranium on the market.

Demand for uranium might indeed rise in the years ahead, but so will supply, and to see what that does to a commodity market look no further than iron ore (or zinc, or nickel, or coal).

Paladin management has always been emotionally attached to uranium, undoubtedly a result of Borshoff’s remarkable rags-to-riches story. It has also been overly emotional in criticising anyone who questions the nuclear power story, and points out the low barriers to entry for rival uranium producers.

Far better for everyone if the facts do the talking, and for Paladin they are not pretty, including collective losses between 2006 and 2012 of more than $900 million from collective revenue in that seven-year period of just over $1 billion.

Paladin’s debts remains high, though an important step was taken in August when the company announced that it had received an up-front payment of US$200 million from a nuclear power utility for uranium to be delivered over the next six years.

The lion’s share of that pre-delivery deal will go into retiring a US$134 million debt, which falls due next March.

Interesting as pre-selling future production might be, the simple fact remains that Paladin is a company suffering the classic resource sector dilemma of producing a commodity for roughly the same (if not more) as what it sells for.

In the 2012 financial year, according to Commbank research, Paladin realised a price of US$55 per pound of uranium sold whereas its mine in the African country of Malawi produced uranium at a cash cost of US$54/lb, and the company’s Langer Heinrich mine in Namibia produced uranium at a cash cost of US$31/lb.

Cash costs in the mining industry can be misleading because they do not take into account financing and other charges.

Also weighing on Paladin is residual net debt that Commbank estimates to stand at US$460 million, even after the pre-sale fund raising.

True believers in the Paladin story, even after seven disappointing years, will stick with the stock, subscribe to the management argument that next year will be better, and that the uranium price is overdue for a rebound.

Jaded observers of the company, who have spent seven years listening to promises of next year being better, will call “time” and question why a company with such a consistent track record of operating at a loss is still value at more than $1 billion.