and something from the archives but still pertinent:
We recommend buying shares in Alliance Resources, which we believe will be the next company to mine uranium in Australia.
Uranium shares are flavour of the year, on the back of an exponential increase in the price of uranium from US$7/pound in 2001 to US$36/pound at the time of writing.
This price increase has been driven by both increasing demand and tight supply. While the price of uranium bumped along at its all time lows in the 1990s, production from existing mines met only 60% of demand. Much of the shortfall was made up by extracting depleted uranium from decommissioned nuclear warheads, mainly from the former Soviet Union. This source of supply is nearly exhausted.
Although uranium is one of the world’s most common minerals, it is found only rarely in commercial grades. Furthermore, it usually takes 5-7 years to bring a new uranium discovery into production, particularly given technical barriers and popular opposition to mining in the countries where uranium is most common, Canada and Australia. With few major mines due to open in the near future, we do not expect the tight supply situation to be relieved for a number of years.
An even more important driver is the demand side of the equation. The story of the 21st century is the emergence into the modern age of the 2.5 billion people living in China and India. Already choked by the pollution emitted from fossil fuel plants, nuclear power is the only realistic option to provide electricity to their vast populations. India, for example, is building 40 new nuclear power stations over the next decade. Even in the West, nuclear power is increasingly being viewed by environmentalists as a "lesser evil" to the likes of coal, as it produces none of the greenhouse gases that contribute to global warming.
Because uranium accounts for only about 5% of the cost of generating nuclear power, and because there are no substitutes, there is no natural ceiling on the uranium price. In real terms, uranium hit a high of over US$200/pound in the late 1970s, more than five times the current price, and some market commentators expect it to hit over US$100/pound this time around. Our more conservative prediction is that uranium will hit US$60/pound by 2007.
While the fundamental outlook for the price of uranium is strong, the current mania for uranium shares appears to be something of a bubble. A number of companies that are hoping to find uranium have gone up 10, 20 and even 30 fold. Day traders - people who buy stocks because they're going up, not because they are fundamentally good value - are gambling on many of these upstarts. We prefer to avoid such hopelessly overvalued companies built on hype that will inevitably come crashing down. Instead, we choose to focus on uranium companies that have already got significant uranium resources and are highly likely to be mining it within a few years. This narrows the field of potential investments down from hundreds of uranium hopefuls to just a handful of serious opportunities.
The market's insatiable demand for uranium related companies was sparked by the phenomenal performance of Paladin over the past two years. Paladin owns the newly commissioned Langer Heinreich uranium mine in Namibia, which has an estimated 44,000 tonnes of uranium at a grade (i.e. the proportion of uranium for every tonne of ore processed) of 0.027%. From a low of 1c in 2004, Paladin is now trading at 187c, giving it a market capitalisation of some $830 million.
With a market capitalization of only $35 million, Alliance Resources has found a larger resource than Paladin’s Langer-Heinreich at its Beverley 4-Mile Prospect in South Australia. Our estimation, based on already released drilling results, is that Alliance has found at least 60,000 tonnes of uranium, and possibly as much as 200,000 tonnes. This would make it the largest uranium find in Australia for 30 years. The grades are higher than at Langer-Henreich (0.03%) and the lithology is sand and silt – which is very favourable for keeping mining costs down.
The estimated size of the resource and the cost of mining it suggest the Beverley 4 Mile prospect will be a hugely profitable operation. We estimate the Net Present Value (net cashflows discounted for time and risk) of this project to be $2.8 billion. Alliance owns 25% of the Beverley 4-Mile prospect, so its share is some $700 million: twenty times Alliance's market capitalisation of $35 million.
Heathgate Resources owns the other 75% of the project, and is 'free carrying' Alliance. In essence, this means that Heathgate pays for all the exploration expenses (drilling, modeling etc) until a decision on whether or not to mine the uranium is made.
Heathgate Resources is a subsidiary of U.S. multinational General Atomic, the largest nuclear company in the world. Heathgate owns and operates the Beverley uranium mine, one of only four licensed uranium mines in Australia, which is just 10km down the road from the Beverley 4-Mile prospect (hence the name).
The importance of having Heathgate as a Joint Venture partner should not be underestimated, because actually mining and exporting uranium (as opposed to just discovering it) is fraught with political risks. All uranium mines need government approval and sales offshore need to be licensed. At the moment, the Federal Australian Labour Party has a ban on new uranium mines. Although Labour is not in power at the Federal level, state Labour parties - which control every state government - are obliged to follow this policy.
Of the states that actually have uranium deposits, the state Labour governments in Western Australia and Queensland currently have no uranium mines and are adamantly opposed to new ones. South Australia, where Alliance’s Beverley 4-Mile prospect is located, is pro-uranium. The state is host to 3 of the 4 licensed uranium mines in Australia, including Olympic Dam, the largest mine in the world. Even though the state government is keen to promote further mines because of their hugely beneficial economic impact, new mines cannot be approved until the Federal Labour Party changes its policy.
This is where having Heathgate as its Joint Venture partner is so beneficial to Alliance. The Beverley 4-Mile discovery can be sold to the public and Labour supporters as an extension to the existing Beverley mine (i.e. not a new mine) and will therefore highly likely be allowed to proceed. No other uranium junior is in such a favourable position.
Now that the initial discovery has been made, Heathgate will spend several million dollars drilling more holes in the ground to get more data and 'prove up' the uranium resource to what’s known as JORC standard. The JORC report is due by December 2006. As noted earlier, we believe the JORC-compliant resource will be around 60,000 tonnes - and, if so, we expect a very strong appreciation in Alliance's share price.
But there is more to Alliance than uranium. Heathgate has identified several highly promising drill targets called M1 and M2. Geologists believe that more enormous Copper-Gold-Uranium deposits like that found at Olympic Dam (the largest mine in the world, mentioned earlier) are very likely to exist in South Australia, and could be common place. But the problem is most of these deposits are probably 4-30km below the surface and impossible to mine, unless there has been some tectonic event to uplift the ore body nearer the surface. The Gammon Ranges, where the M1 and M2 drill targets are located, were once 50,000ft high (taller than Mt. Everest). The theory is that a massive Copper-Gold-Uranium deposit may have been pushed to the surface at M1 and M2.
The drill target is large (200m thick x 1500m x 1500m). In a best case scenario, it could average up to 10% Copper, 8g/tonne gold, and 0.1% uranium. That's approximately one billion tonnes of ore that could contain 10M tonnes of copper, 280 million ounces of gold, and 220 million pounds of uranium, worth around A$10-15 billion. Alliance's share, $2.5-3.7 billion, is some 300 times its total current market capitalisation.
Finally, Alliance owns 100% of the Maldon Gold project in Victoria. The project has had about $40 million spent on ventilation shafts and a processing plant by previous owners. The project was mothballed due to low gold prices some time ago, but the company is spending $5m to find out whether it is economic to open the mine. In a worst case scenario fire sale, the plant and lease at Maldon is worth around $10m or 5c per Alliance share. In a best case scenario, Maldon will produce 1-2 million ounces of gold per year for the next two decades, generating an annual profit of around $10 million. In this case, Maldon would be worth more than $70 million to Alliance (about 30 cents per share, or twice Alliance's current market value).
With cash of around $2m and a current market capitalisation of $35 million, this means investors are paying at most only $23 million for the Beverley 4 Mile discovery (which we value at closer to $700 million), and getting the massive upside potential from M1 and M2 for free. We recommend investors make a worthwhile investment in Alliance before the market wakes up.
AGS Price at posting:
40.2¢ Sentiment: Buy Disclosure: Held
