From being the top uranium stock in 2016, Cameco Corp. (CCJ -0.50%) made a complete 180-degree turn to end up as the worst-performing uranium stock in 2017, having shed 12% during the year. Even a company like Denison Mines (DNN -0.49%), which is still in the development stage of the uranium mining business, is closing the year in the green.
So what went so drastically wrong for Cameco in 2017, so much so that investors lost whatever little hope they had gathered in 2016 about a recovery in the uranium markets and the stock? Is Cameco seriously in trouble or are the markets overreacting? Let's dig deeper.
Why 2017 was a challenging year for Cameco
Cameco started 2017 on a pretty strong note, extending its last year's gains and piling on 6% in just the first two months of the year. Investors were glad to see Cameco end fiscal 2016 with adjusted net income of $143 million, and realizing 60% higher prices than the spot uranium price, thanks to sales under its pre-fixed rate contracts.
Sadly, the good news for Cameco ended there. The stock soon reversed its course and kept heading lower, even hitting its 52-week lows in October. Blame uranium prices and a lost contract.
2017 was a bad year for Cameco stock, but investors can remain hopeful about 2018. Image source: Getty Images.
Cameco got a bolt from the blue in early 2017 when Tokyo Electric Power Company, or TEPCO, abruptly terminated a uranium supply contract that was supposed to run from 2017 through 2028, citing "force majeure." It was, of course, a huge setback for Cameco at a time when it was already struggling to grow its top line amid low uranium prices.
Meanwhile, uranium prices continued to slide, and Cameco's losses widened over the course of the year. In October, Cameco reported 13% lower revenue and a net loss of $143 million for the nine months ended Sept. 30, 2017, compared to a profit of $83 million in the year-ago period. Unfortunately, that wasn't the worst news in Cameco's third-quarter earnings report.
When investors lost hope in Cameco
Cameco shares crashed soon after its Q3 earnings release after the uranium miner dropped two bombs that sent investors scurrying for cover: It announced a temporary suspension of operations at two of its key mines, McArthur River and Key Lake in Saskatchewan, and slashed its annual dividend by a whopping 80%. So far, Cameco had maintained its dividends even after the 2011 Fukushima disaster that brought the global nuclear energy industry to a grinding halt.
Cameco's moves to cut production and dividends were much needed, as CEO Tim Gitzel explained:
With the continued state of oversupply in the uranium market and no expectation of change on the immediate horizon, it does not make economic sense for us to continue producing at McArthur River and Key Lake when we are holding a large inventory, or paying dividends out of proportion with our earnings.
Investors now fear that Cameco could be headed for deeper trouble, but that may not be the case.
A prudent approach to the future
There's more to Cameco's production cut than meets the eye.
First, because Cameco is the world's largest uranium producer, there's hope that its production cuts will have a bearing on demand and supply and help uranium prices find support. That explains why stocks like Denison soared when Cameco announced the cuts.
Second, and more importantly, Cameco sells a substantial amount of uranium at spot prices, which it doesn't want to anymore, given the weak prices. By slashing production, the company will now draw down on its inventory only to fulfill contractual commitments and avoid spot sales altogether. So for FY 2017, Cameco expects to produce 24 million pounds of uranium but deliver 32 million-33 million pounds. In 2018, I expect production to be even lower in 2018 against the company's committed sales volumes of 28 million-30 million.
Industrywide production cuts could fuel a recovery in uranium prices. Image source: Getty Images.
In short, Cameco is making several smart moves in one go, including cutting down production, avoiding low-priced spot sales, slashing costs, and reducing inventory and dividends to prevent cash burn. The last bit is particularly important for two reasons: Uranium prices remain low and Cameco's long-term contracts are nearing expiry. If prices don't recover, Cameco will have to lock in fresh contracts at low prices, which is when a strong cash flow backup could come handy.
What to expect from Cameco in 2018
Cameco is taking prudent measures and striving hard to position itself for a recovery in the uranium markets, but if there's anything that could stifle the company's growth, it's a struggling nuclear power industry.
On the positive side, Japan is restarting some reactors while high power-consuming nations like China and India are building some. Meanwhile, the world's largest uranium-producing country, Kazakhstan, is trimming production to help rebalance industry demand and supply. On the negative side, nations such as the U.S. and France are moving away from nuclear power, which could put a cap on the demand and prices for uranium in the long run.
I'd say investors need to adopt a wait-and-see approach with Cameco. If the company can control losses and report better numbers in 2018, backed by its aggressive cost reduction moves, the stock could bottom and fetch investors better returns in 2018.
