At its core, Cameco Corporation (NYSE:CCJ) is in the mining industry, competing with companies like Rio Tinto plc (NYSE:RIO). The big difference is that Cameco exclusively mines uranium, which is used as a fuel in nuclear power plants. This makes it important to understand some dynamics that most other miners don't face.
A niche market
So the first thing to note about how Cameco makes money is really what it doesn't do. It's a miner, so finding commodities, digging them up, processing them, and selling them is the basic business model, as with miners like Rio Tinto. But unlike Rio and most other miners, Cameco is focused exclusively on uranium. You could get exposure to uranium by owning Rio Tinto, but uranium made up only 1.3% of Rio's revenues and 0.4% of EBITDA in 2016. At Cameco, uranium and uranium-linked businesses basically make up 100% of revenues.
Thus, Cameco is a very focused company that really only serves one major industry -- electric utilities. And even that's too broad a view of the company since uranium is really only used for a subsector of that industry: fueling nuclear power plants. If you are even considering owning Cameco, you need to get your head around what's happening in the global nuclear power plant niche.
That's a mixed bag right now, with developed markets increasingly moving away from nuclear power while emerging economies, like China and India, continue to build new plants. In total, there are around 55 new nuclear power plants under construction today, most of which are in Asia.
Cameco touches the nuclear power market in three ways. First, it mines uranium, a business that made up roughly 70% of revenues in 2016. Note that revenues in the uranium business can be lumpy because deliveries are made periodically in large amounts, rather than small amounts spread evenly over time. So examining one quarter of Cameco's results won't give you a full picture of the business.
Cameco also operates a fuel services business, which accounted for 13% of the top line in 2016. This segment takes raw uranium and processes it so it can be used in nuclear power plants.
The final business, called NUKEM, accounted for the remainder of Cameco's revenues last year. This business operates as a middleman in the uranium market, buying and selling uranium on behalf of customers.
There are two big issues that this quick overview makes very clear: First, mining is the most important business for Cameco. Second, everything Cameco does is tied to the global nuclear power sector. I've said that already, but this fact is, perhaps, the most salient feature of this business.
Some bits and pieces
That said, there's some other things to keep in mind here. For one thing, Cameco tends to be conservatively managed. This include a modest debt load at around 20% of the capital structure at the end of the second quarter and a very strong current ratio of 5.8.
But the company's conservative nature also means focusing on long-term contracted business. When uranium prices are high, Cameco's contracts will limit its upside. However, when uranium prices are low, as they are today, contracts help protect its revenues. To give you an example, in 2016 uranium spot prices hit a 12-year low. Because of its contracted business, however, Cameco was able to charge 60% more than the average spot price for the year.
The problem here is that there are only so many companies in the world that operate nuclear power plants, so Cameco's customer base is pretty small. And spot prices have a big impact on the desirability of contracts; as you might expect, low spot prices depress demand. Since contract activity has been slow (in fact, some customers have been attempting to cancel contracts lately) there's a bit of a contract cliff to watch out for. At this point Cameco believes its contract book is in good shape out until 2021. If uranium prices don't pick up by that point, Cameco and its shareholders could be in for a shock.
The basics -- now start digging
If you are looking to understand how Cameco Corp makes most of its money, the answer is simple -- it is exclusively focused on the the uranium market, which means investors in Cameco need to understand what's going on in the nuclear power industry. However, under that there's some important nuances. For example, it operates fuel services and brokering in addition to uranium mining. And perhaps even more important, the contract nature of its business can be both a positive and a negative.
But now that you have all that as background, you'll be better equipped to do a deep dive and see if Cameco and its 3.2% dividend yield deserve a place in your portfolio.