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 MARKET REPORTS |
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Stocks
Stock of the week – Energy Resources of Australia
June 19, 2008
Tim Morris, wise-owl.com analyst
Company: Energy Resources of Australia Ltd
Code: ERA
Recommendation: Buy
Market Cap: $4.3bn
The wardrobe of any self described fashionista is likely to host a handy collection of outfits once deemed hot, but now ‘definitely’ not. Such collections are handy because while such elitist fashion crowds re stock their wardrobe on a seasonal basis, the ‘old rags’ are left for the bargain hunters that frequent the op shops and garage sales. Designer jackets that were once several hundred dollars can be found for a fraction of the price for simple reasons such as ‘pockets are soooo last season’.
So why reserve fashion talk for a stock tipping column I hear you wonder?
Well, stock markets can behave in exactly the same ‘fashion’, as crowds of day traders get carried away on particular investment themes. Throughout 2006 and for the first half of 2007 one such theme was uranium. As investors engaged the ‘nuclear renaissance’ as a solution to the world’s future energy needs and climate change issues, the share prices of companies within the sector went crazy. The trend saw many resource companies claim some form of uranium potential within their leases, and a stack of new uranium focused floats hit the market, with some of the more ambitious promoting leases within states that ban ‘yellow cake’ mining.
Underpinning this trend was a strong rise in the uranium spot price from under US$20/lb in 2004 to heights of US$138/lb in August last year. This price peak coincided with the broader ‘sub prime’ induced market correction, a strong combination that served to burst the bubble which had formed in the sector.
The ‘fallout’ over the months that followed saw share prices of hopeful uranium minnows across the board suffer severe pain and the uranium spot price retreated to recent levels of US$60/lb. As a result this once hot sector appears to be ‘on the nose’ for most investors.
However, it is when the crowd’s attention is focused elsewhere that great opportunities can arise. With the oil and gas prices at record highs, the fundamentals behind alternative viable energy sources such as uranium remain solid. Now that the speculative froth that gripped the sector has eased, the companies that will actually benefit are set to be revealed.
We believe Energy Resources of Australia Ltd (ERA) is one such company, being one of only two pure play uranium producers on the Australian market. ERA happens to one of the largest uranium producers in the world, providing 10 per cent of the world's uranium production. The company has a long history, operating the Ranger Mine in the Northern Territory since the early 1980’s. When the company was floated on the stock exchange in 1980 it was at the time the largest public float in Australian history.
The Ranger Mine sits on one of two leases held by ERA on Aboriginal land surrounded by, but separate from, World Heritage Kakadu National Park in the Northern Territory.
Producing 5,412 tonnes of yellowcake in 2007, Ranger is the second largest uranium mine in the world. However a legacy of forward agreements from years past means that ERA has been locked into lower than market prices for their product, with the average realised price being US$25/lb. But this didn’t stop net profit increasing 74% during 2007 to $76m, and as more long term sales contracts ‘roll over’ we expect the company to benefit from stronger pricing in the years ahead.
The ‘official’ life of the Ranger mine was last year extended from 2008 until 2012 as an additional 4,857 tonnes of U3O8 were added to reserves, which now sit at 49,671t. The company is currently investigating other expansion options, which may involve converting its additional 43,253t of resources to reserves. So while the official mine life appears short, the company appears to have enough yellow cake on its hands to keep things ticking over for a while longer.
In terms of its valuation, investors may be better off covering their eyes rather than looking at the current year PE ratio, which is almost 50. However, investors are banking on a future ramp up in earnings, and the consensus December 2009 PE is more digestible at 24, falling to 11 by 2010. Although hard core value investors may disagree with this valuation, we rate the stock a ‘high risk buy’. From a technical perspective the stock is looking ripe for a fresh rally, recently breaking on the upside from a year long symmetrical triangle pattern. Should the stock hold above $20, we are bullish on the technical outlook.
But given the high valuation, any unexpected production shortfalls are a key risk facing the stock, as witnessed last year when the share price just about halved when heavy rains flooded the Ranger mine. So it will pay to keep posted on this one, which we will certainly be doing for members this week when we publish our special quarterly updates edition, which provides our up to the minute views on all our open recommendations, including many of those discussed in this column.
Tim Morris is an analyst at wise-owl.com, one of Australia's leading independent stockmarket research houses. Click here for your complimentary report.
Please note that CompareShares.com.au simply publishes analyst reports on this page. The publication of these reports does not in any way constitute a recommendation on the part of CompareShares.com.au. You should seek professional advice before making any investment decisions.
More articles from this edition of CompareShares:
Property: Where is the property market headed?
China stocks: Yes, you can buy stocks in China
Stocks: Stock of the week – Energy Resources of Australia
Trading: June is usually a bearish month and July is bullish
Economy: Britain 'will beat off' recession threat
Acquisition: ACCC begins action against ABC Learning
Commodities: Imports surge but demand for oil wanes
Commodities: Rhodes Ridge crucial for production: Rio
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