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Wednesday, February 14, 2007

Strathmore Minerals (STHJF) exclusive negotiation

Strathmore (combined links) issued this press release today.

Here's how I interpret this: A company like Cameco or Cogema ("Cogeco") paid Strathmore $100K to sit down and discuss the terms for a joint venture exclusively for 90 days. Cogeco didn't want Strathmore playing them off "Camema" or anyone else while doing the negotiations. But regardless, thanks to the work that they've done before everyone got the uranium bug, Strathmore has some good low production-cost properties based on the huge Kerr McGee database that can go into production reasonably soon while there are more than one uranium mining companies to compete for them. I would expect Strathmore to be in a fairly good negotiating position right now.

If this deal is anything like the last one we saw, the terms are probably going to be pretty good for Strathmore. Any uranium that can go into production in the next 8 years is going to pay off well.

Roca Honda is on the order of 30 million pounds of uranium plus what I understand would be the only uranium mill in the Grants region. Based on the presentation by Strathmore (page 9), Roca Honda would be going into production at the start of 2013. While this is a long way out, they're actually pretty early compared to most other uranium mines that aren't even close to permitting yet. Cigar Lake will go online within a year or two (or three or...), so will some others. But those will only make a moderate dent in the demand/supply imbalance based on the numbers that are out there.

Looking at that presentation, here's what Strathmore is hoping for in terms of production (assuming they get the permits). The early stuff has a low cost of production. They show Roca Honda cost of production being $20 per pound or less (not sure if that includes milling). The profits from the uranium would probably be split with the operations company, perhaps 50/50, perhaps better.
This is in pounds of U3O8.

2010: 500K
2011: 500K
2012: 1 million (what happens if uranium spikes at $150/lb at this point?)
2013: 1.5 million
2014: 2 million
2015: 3 million
2016: 4 million (uranium prices will probably settle back around $65 at this point)
2017: 5 million
and so forth

With a comodity in an equalibrium situation, the selling price is generally at around the marginal incremental cost of production, which industry people seem to think is around $65 for the long term equalibrium at the expected future demand.

UPDATE Feb 15:
A new interview with a Strathmore VP shows that neither Church Rock nor Roca Honda is affected by the ruling on Native American land vs uranium mining.

DeJoia also explained, “We are not on any Native American lands and there are no Native American lands adjacent to us. We have private property in the area, ranch lands, and other mineral holders. There is no checkerboard Indian ownership in the area. The community is predominantly non Native American.”

DeJoia told StockInterview, “This ruling basically doesn’t affect our schedule at Church Rock or at Roca Honda. We will currently do all the work we had originally planned to move our projects toward permitting.” He added, “We’ve started activities toward a mill design for the area.” According to DeJoia, Strathmore Minerals plans to start drilling to obtain background water data and complete a ‘radiation walk-over’ survey this spring.

worried about valuations.

your production figures,
cost goes up from 20 to 35 in 2016 and stays there,
price is 80 until 2015 and 65 after,
profits are 50%,
discount rate 10%,
share count 100M,
production ends in 2022 at 5M lb.

share value comes at USD 2.6 today.

Your thoughts?
First of all, I don't know of any way of getting a 10% risk-free interest rate. For this particular business, it's very sensitive to the assumed risk-free rate. Keep in mind that for long term projections, it's more accurate to have uranium prices scale with inflation. Although that may not happen, the dynamics of the industry look pretty good for the uranium price for a long time into the future.

My estimate of risk-free interest rates after inflation for the long term future are along the lines of 6% or so. And I consider that a bit pessimistic.

Strathmore plans to ramp up to 8 million pounds per year in 2020 and pretty much remain there.

Another thing is that valuation depends a lot on when you truncate the free cash flow in time. A reasonable way to truncate it is to take the very long term earnings of the business, slap a P/E of 15 onto it at the termination point, and discount that back to the present.

Also, I haven't done a detailed check yet, but it's starting to look like the totally diluted share count will be less than 100 million. Strathmore is claiming 77 million shares diluted. The recent deals don't seem to involve heavy dilution like in the past.

Even with 100 million shares, I figure the present value of the stock is around $12 per share, which is more or less what I expected.
OK. I didn't use terminal value because I thought you used all the resources. I see they claim to have over 300,000 theoretical pounds in the ground.

I still see some problems with your valuation.

RE: Discount rate. I don't think the risk free rate is appropriate. STM's cash flow to investors is after all anything but risk free, and I doubt anyone will finance STM for less than 10%. Moreover, there is the opportunity cost of investing in STM, which isn't the CD rate, but the expected return of your next best investment. Anything south of 10% seems low. I'd use 10% as a minimum . For a Buy decision I'd use 15%-20.

Re: terminal value, this is a mining company with finite resources. When resources are exhausted it is the end of it. A P/E of 15 at maturity seems excessively high. 10 seems more reasonable. On the other hand, STM claims to have over 300M lb of U3O8 in the ground, enough for 30 years. So I'll use a terminal P/E of 12.

And I corrected the share count to 80 M.

That gives me a value of $7.88 (and a buy below $4.57)

With a P/E of 15 these are 9.07 and 5.21.

using 6% discount I get $14.53. But when a non producing miner has the same risk profile as a CD, that's isn't a valuation, it is a SELL order.
The purpose of discounting over time is not to adjust for risk but to account for the time cost of money: a dollar today is worth that much more than a dollar next year. If there's risk involved, then it makes sense to be conservative with estimates of future free cash specific to each risk, but not use the discount rate which is a blunt instrument that could overdiscount the distant future and underdiscount the near future, regardless of which one is more certain.

Using a high discount rate overempasizes the near-term over the long-term, which is exactly the sort of bias the stock market already has. Thus it is likely to miss opportunities of mispricing based on that bias.
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