+ Yellow Cake PLC offers a low volatility way to play uranium.
+ Offers immediate upside with sizeable current discount to NAV of c30%.
+ Is well placed to further add value in a tightening uranium market.
I think that Yellow Cake (YCA) currently offers new investors in uranium the lowest risk way of accessing the market, with limited downside due to it trading at a c30% discount to its underlying NAV, with large potential upside, first by simply reducing the current discount and secondly as the anticipated increase in uranium prices helps increase its NAV.
With the current spot price of the commodity trading below the often quoted average price to produce the metal, a recovery in the space has been predicted by many. I won't go into the detailed background to why uranium is a compelling space to invest in at the moment, that's been covered elsewhere.
The reality, however, to investing in the uranium market is that you need a tough stomach. Outside of the two physical vehicles (Uranium Participation Corp and Yellow Cake) there are just two major miners, and only one of which is easily accessible to most western investors, Cameco. Therefore the typical investor is left looking at junior mining stocks as the only way to play the sector. Prices of these junior mining equities can fluctuate wildly with the smallest moves in the underlying uranium price, the expansion or not of the various deposits they are developing, the latest drill results, or the ongoing annual costs of their management teams. With the great uranium bull market taking longer to materialise than many have thought, these should be important to the longer term, patient, investor who is prepared to wait for the underlying uranium price to rise but doesn't want to pay too much to wait.
Looking at the two physical options, both Uranium Participation Corp and Yellow Cake have similar business models - that is to buy and sequester physical uranium until such a time that prices have improved and then realise that uplift in value. They are slightly different, UPC being the longer standing equity in the space, listed on the TSE and managed by Denison, one of the larger developers in uranium that have also been around for a while. UPC hold uranium in their two most common forms, U308 ("yellowcake") and UF6 (a gaseous form that can be enriched in preparation for loading into nuclear reactors). They have recently been reducing their holding of UF6 and buying U3O8 so they are becoming more focused on being a U3O8 pure-play.
Yellow Cake are listed in London and floated in July 2018 so are relative newcomers to the uranium market. Their business model is to purely buy and hold U3O8, buying at the bottom of the cyclical market, and then to monetise that material when uranium prices have risen. The business owns c$320m worth of uranium in today's money, but offers a very low cost model with minimal storage costs and G&A costs of c1% p.a.. This means investors can effectively play the anticipated rise in uranium prices without the risk of running mines and not suffer from large annual dilution that non producing assets often incur. With the timeframe to a full uranium recovery uncertain, this is an important feature of what makes Yellow Cake an interesting investment proposition.
They purchased their initial material from the worlds largest uranium miner, Kazatomprom, a Kazakh entity who is known to be one of the lowest-cost producers in the world. Storing physical uranium is clearly a sensitive task, and Yellow Cake have an agreement to use the licensed storage facilities that Cameco own in Canada for their storage (cf Yellow Cake press release). They also have long term purchasing agreements with Kazatomprom to continue to add to their stockpile should they wish.
When the fund launched in July 2018 it was heralded in the space as the first sign of new serious money coming into the market. The last time uranium ran various funds started buying and storing physical uranium as a way to tighten supply further and lever the market higher. Yellow Cake's raise of $200m was seen as a lot of money coming into the space near the market lows of late 2016. Uranium is not a big market, with perhaps the combined market caps of all the uranium producers in the world being around $8bn.
Source: Contrarian Investments
This graph shows the performance of Yellow Cake since launch, with the orange line depicting the closing share price and the green line showing the actual underlying NAV of the funds physical uranium, at the prevailing spot price. The blue line shows the daily volume trade in the fund. You can see that when the fund first launched, it helped propel uranium prices higher, driving up the NAV in doing so. We believe the primary reason for this is the perceived market tightening that the new fund brought to the space. As the NAV is a proxy for the underlying price of uranium, you can see that the price of uranium then plateaued for several months before drifting south. However the share price of Yellow Cake fluctuated a little more, rising to a slight premium in the heady days just after its launch before drifting to trade around par value, occasionally dipping to a discount.
Things started detaching more during summer of 2019. As you see in September, there was a spike in volume. In reality this reflected an original shareholder - a hedge fund based in London - going into liquidation and needing to offload its stake in Yellow Cake quickly. The size of their position was material - approaching 7% of YCA. We postulate that the opening of the discount in August was related to that liquidation, which was only registered in September once it had cleared through. Yellow Cake continued to trade below value for a few months more before coming back in line to its underlying NAV. This was prompted by the fund managers recognising the sizeable discount to NAV and first threatening, and then enacting, a gradual buyback to help create buying pressure to reduce the discount.
Then you can see the effect of Covid-19 on the fund. As you will likely know if you are reading this, the various lockdowns across the world have created a major supply shock to the uranium market, with many of the worlds largest mines being shuttered for a period whilst the world grapples with the virus.
Source: Contrarian Investments
From this graph you can see the impact of these supply restrictions on the price of uranium (the yellow line), they have skyrocketed to $34/lb from a base of $24/lb, an increase of over 40% in less than a month.
However, the blue line, the premium or discount that Yellow Cake trades at to its NAV, has not performed so well. As you can see, it has spent most of it's life between +5% and -10%. Currently, the discount remains suppressed at close to its extremes since the launch of the fund, and at the time of writing is just shy of a 30% discount.
Why? One thought is that the recent rise in uranium prices is temporary, with supply coming back online once Covid-19 issues are in the past driving prices south again. Another fund has just reduced its position by over 3m shares which has also contributed to the discount remaining suppressed.
A supporting reason for this is a little more technical, in that the price of uranium shown here is the futures price of uranium delivered to Cameco in Canada. If you look at the futures price of uranium delivered to locations elsewhere in the world, they are hovering around $30/lb which would in turn mean a smaller discount. Clearly investors believe that the premium in spot prices for delivery to Cameco is short lived, otherwise Yellow Cake wouldn't be so discounted. Reducing the current spot price to $30 brings the discount down to nearer 20% though, still sizeable.
We think the market is missing something here. Yellow Cake continues to trade at a sizeable discount of 20-30% to NAV, far beyond its peer of UPC. Cameco is in the spot market buying uranium right now, to help it meet its contracted sales commitments of 2020. They have given no indication that Cigar Lake (their last producing mine which was recently shuttered due to Covid-19) will come online any time soon. Their CEO Tim Gitzel said on the Q1 2020 earnings call 'a true uranium price that's moving rapidly up it is setting the environment for the terms and conditions that we need for the new contract portfolio to bring back Cigar and McArthur'.
They have said it's becoming increasingly difficult to purchase sufficient U3O8 in the right quantity and location for their needs. Yet Yellow Cake is sat on 9.6m lbs of it, in the right location. Yellow Cake are in the powerful position of being able to 'lend' U3O8 to Cameco to enable the miner to meets its obligations. This gives Cameco the ability to buy time to better judge the market for when is the right time to reopen Cigar Lake and to enable them to reduce the impact of their spot uranium purchases, with Yellow Cake knowing that Cameco will be able to replenish that stock once their mines are operational again. A sale of part of the Yellow Cake reserves would be accretive to YCA shareholders given the current discount and Cameco would also save a bit of money. Whether Cameco could ever face buying Kazakh uranium via a middleman is to be seen, but it remains a possibility if they struggle to find the volume elsewhere.
We also think that Yellow Cake offers a great entry to the uranium market for investors new to the space. Some of the mining equities are near 1, 2 year highs, and whilst we are very bullish of the long term fundamentals driving this market, they represent some possible short term downside, Yellow Cake is currently at a near 30% discount to NAV which effectively gives new investors an entry to the uranium market at prices before the recent increase. Yellow Cake is a less liquid and newer entrant to the uranium market, but we think that is why this value opportunity exists today, and as has been proven above the discount to NAV does shrink from its extremes. Even with flattening uranium prices we believe there is good upside potential with Yellow Cake.
If you'd like to do your own research on the discount of Yellow Cake then click below to download the data file for the above article. I should add that we have ignored the buyback program currently underway, mainly because it would be a faff to collect the data and the scale of the buyback is so small it wouldn't make a meaningful difference to these calculations.
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