It's been a dramatic few years for Energy Resources of Australia (ERA), one of the world's most significant uranium producers. At the turn of the century the company was very much under the radar, given no one was remotely interested in uranium at the time. But the accelerating build-up of climate change fear, and the subsequent re-emergence of nuclear power as a fuel alternative saw ERA's shares begin to move from their $2 or less share price. Then when the oil price started its run, suddenly we were facing a nuclear revolution. The uranium price ran amok on fervent speculation.
ERA's price took off by association, until wise heads began to point out that ERA had a fundamental problem – uranium spot prices might be heading to the moon but ERA had signed contracts that locked in long term prices. It mattered not that spot uranium was rushing from US$15/lb to US$100/lb, as ERA was locked in to continue providing yellow cake to power plants at US$15/lb.
What made life even harder for analysts is the fact the company would not let on as to what sort of obligation remained at what were now long-forgotten uranium price levels. This made it hard when Australian analysts started jumping on the uranium bandwagon. ERA had mostly been covered under the banner of 67% owner Rio Tinto ((RIO)), but the uranium price explosion encouraged brokers to initiate a separate coverage. Where to pitch a target? With the uranium price soaring, numbers above $20 became popular.
But not in JP Morgan's case. JPM's analysts remained steadfastly on an $11.11 target as all about were upgrading in leaps and bounds. Their argument was one of transparency, and until they knew exactly how much uranium ERA still had to sell at US$15 or so they were not going to budge. That is, until their US parent suddenly decided to lift its uranium price forecast exponentially, and the red-faced local analysts were forced to upgrade all the way to $31, thus moving from way below to way above consensus.
Uranium price speculation soon bubbled and burst, while 2006-achieved prices for ERA still looked a bit restrained at around US$18/lb. But there was no doubting ERA's potential as a major player in a global nuclear future. Ranger is one of the world's biggest mines, a lot of the area surrounding is only now being explored, and there is always Jabiluka – a source potentially greater than even Ranger, stuck in a national park. Brokers were mostly content to reduce their initial exuberant targets, but not by that much.
Until the rain came. Ranger was flooded, and this was a big problem. Fortunately ERA had stockpiles of uranium ore lying around on site, mostly low grade stuff. But high prices meant even this low grade stuff had become economical, and new technology also helped. The obvious conclusion to make was that ERA could satisfy its contracts via its stockpiles while the pumps worked overtime. And the company had spent 2006 building up inventories of the good stuff anyway.
Well blow me down if mysterious ERA didn't surprise everyone on Friday with its 2007 result. Consensus earnings were around $46m, but the result was $76m. The difference, however, came down to the inventory situation. ERA had continued to build, rather than deplete. Adjust for that valuation and the numbers come out basically in line.
The other pleasant surprise, however, was the net price of uranium achieved. US$25/lb still seems poor against the current spot uranium price of circa US$78/lb (notwithstanding where it's been), but the increase over US$18/lb implies those legacy contracts are in the process of rolling off. And what this further implies is there is a significant leverage upside for a company solely in the business of producing uranium. The jump to realistic pricing may occur quicker than analysts were prepared to hope.
ERA indicated it did not expect its sales volumes in 2008 to be any increase on 2007. This is not particularly concerning, and in fact is better guidance than some analysts had pencilled in. The other good news is that unlike just about every other miner in the country, ERA did not appear to suffer from outrageous operational cost increases. There was an increase in exploration write-off, however, which is also a common theme.
All up, analysts are well pleased. Macquarie was pleased enough to lift its Neutral rating to Outperform, thus bringing the B/H/S ratio in the FNArena database to 6/2/0. Macquarie also lifted its previously cautious target from $18.75 to $23.45. A previously more ambitious ABN Amro reduced its target slightly, the end result being an increase in the database average from $23.66 to $23.96.
ERA has rallied over 3% this morning, to see the share price return above $20. The upside in analysts' targets stems to some degree from an expected eventual bounce in the uranium spot price from current levels, but mostly from the latent exploration potential embedded in ERA's fortunes. More uranium, a higher price, and the final burial of those legacy contracts ahead puts ERA in good stead as we move into a new era of energy generation.