Uranium demand is putting miner Cameco back on investors’ radar

The outlook for uranium, moribund for some time, is looking up.

And that means shares of Cameco Corp., the Saskatoon-based miner one analyst calls “the only real blue-chip stock in the sector,” are up, too – about 20 per cent from their 52-week lows. The stock has received a host of upgrades, with analysts at CIBC World Markets, Canaccord Genuity Corp., and Merrill Lynch all moving to “buy” ratings so far this month – even before Wednesday’s blockbuster announcement of a deal for Cameco to supply India’s nuclear sector.

Cameco itself, however, has been keeping short-term expectations modest, setting sales guidance for 2015 that’s lower than last year. While president and CEO Tim Gitzel says the company sees “exceptional growth on the horizon,” he also acknowledges “the uncertainty in the uranium market has persisted for longer than expected.”

Add to that another uncertainty: Cameco’s burgeoning battle with tax authorities, both at home in Canada and on a new front in the United States, where the Internal Revenue Service is laying claims on Cameco similar to the Canada Revenue Agency’s.

Neither the near-term outlook nor Cameco’s tax woes have held back the bulls, as 14 of the 21 analysts covering the company now have “buy” ratings on the stock, expecting uranium prices to exit their trough and return to higher levels. Taken together, however, the caution lights of the spotty uranium market and the company’s tax troubles suggest Cameco shares may hit a few bumps in the next year or two during its ascent.

Certainly, the news of Cameco’s India deal is good: The company has signed a deal to supply the country’s department of atomic energy with 7.1 million pounds (3.2 million kilograms) of uranium concentrate through 2020. This, notes Cantor Fitzgerald Canada analyst Rob Chang, is a “landmark deal” that gives Cameco access to the world’s second-fastest-growing uranium market after China.

The deal overshadowed news from Tuesday, however, that speaks more to the company’s near-term concerns: A Japanese court blocked the restart of two nuclear reactors in the city of Takahama, tied to a dispute over the results of an assessment of earthquake activity in the region. The Japanese nuclear industry has been in rebuilding mode – literally and figuratively – since the Fukushima disaster in 2011. Bringing the country’s reactors back online, with their needs for fuel, has been a key part of the thesis for a rebound among uranium miners.

“Japan is just one of several drivers – but it is likely the largest psychological issue,” says David Talbot of Dundee Capital Markets. “Industry stakeholders for the most part are tired of waiting for the Japanese restart catalyst, us included.”

Mr. Talbot – the analyst who made the “only real blue-chip stock” comment about Cameco – argues investors should put more focus on other possible positives, either supply disruptions such as the breakdown of BHP Billiton’s Olympic Dam in Australia, or potential sanctions against major uranium player Russia for its role in Ukraine, or demand growth from a potential Chinese resurgence.

The China theory is part of the Merrill Lynch upgrade from “neutral” to “buy” Monday, with the firm’s analysts citing 29 reactors under construction and a potential 30 more by 2023. While Cameco waits for the long-term demand, it has “a strong portfolio” of long-term contracts through 2018 with prices 15 per cent to 30 per cent above “depressed” spot prices of $39 (U.S.) per pound. These long-term deals “will allow it to be patient when negotiating new contracts.” (The analysts’ new price target is $23 Canadian).

Canaccord’s Gary Lampard, who also raised Cameco to “buy” and a $23 target price, says he expects the global uranium market to be in surplus until 2022 – but the shortages he sees beyond that point will cause utilities to be “more aggressive” in securing uranium by 2018 or 2019, when the price will be $70 per pound. (Cantor Fitzgerald’s Mr. Chang, who has a $26.15 target price, says “a violent upward move in the price of uranium is inevitable based on an unavoidable supply deficit occurring in 2020.”)

What will likely happen before then, however, is a resolution of Cameco’s tax battle with the CRA. I first reported the dispute in May, 2013, based on a report by the analysts at Veritas Investment Research. Since then, Cameco’s disclosures have increased as the potential tax bill has grown, and analysts have become more concerned, with the CRA dispute the top topic at the company’s November investor day.

A quick recap of the tax issue: Starting in 1999, Cameco minimized its tax bill by running sales through a subsidiary in Zug, Switzerland, where the tax rate is lower than in Canada. The core issue in the dispute is “transfer pricing,” when a company does deals with related parties. The CRA began contesting the structure of Cameco’s deals and its transfer pricing methodology in 2008, but Cameco had enough accumulated losses to cover the taxes CRA said it owed.

Over the past few years, however, Cameco saw the bill grow because it no longer had the losses to offset the alleged extra tax bill. Cameco now estimates CRA will claim it has $6.6-billion more in taxable income than Cameco reported from 2003 to 2014, resulting in a tax expense of $1.9-billion. Transfer-pricing penalties, interest and other penalties could add more.

Cameco revealed in its February earnings release the U.S. Internal Revenue Service is now pursuing similar arguments, claiming Cameco owes $32-million (U.S.) for 2009 alone. The IRS is auditing 2010 through 2012, Cameco says.

The Canadian case is scheduled to be heard in the Tax Court of Canada in 2016; Cameco says it is “confident that we will be successful in our case.”

Analyst David Sadowski of Raymond James Ltd., who has a “market perform” rating (equivalent to “hold”) on Cameco says, however, “We believe entry of the IRS further shifts the balance of probabilities toward a negative tax outcome for Cameco.”

He “urge[s] investors to look to other vehicles for exposure to a [possible] 2015 rebound in uranium prices and sentiment”; specifically, he recommends Denison Mines Corp. (DML), Fission Uranium Corp. (FCU) and Ur-Energy (URE), a trio of TSX-listed companies each well below $1-billion in market capitalization.

In short, he says he’s “bullish on [the] 2015-16 uranium price outlook, but not on Cameco.” Investors with a long-term focus on uranium trends may benefit from buying Cameco now; those expecting a smooth path for the shares, however, should probably heed the warnings.

Cameco’s TSX-listed shares closed Friday at $19.70, down 5 cents.