The uranium industry, which had stellar price run-ups in 2004-2007, has come back down to earth — down about 71% from the high of almost $140/pound in 2007 to just under $40 in June 2013.
A $70/pound price is the level where new development and mines are seen as feasible now, so at almost half of that, the short- and mid-term supply may become constrained as the world has to get back to generating energy. China alone is planning to build 30 new plants in the next three years, adding to its currently operational 15 plants — tripling total energy generation. It and many other countries like India are looking to source the ore.
Australian uranium production is constrained by regulatory limits and restrictions, as well as negotiations with traditional landowners to enter and work in their lands. A number of explorers and companies have proven or probable resources, but they may not be able to produce anytime soon.
When the world ore supply can't keep up with demand, the advantage is with the current producers. Uranium processors needing to order ore have long lead times, and if there is more competition for available resources, then the ore price will have upward pressure.
Energy Resources Australia (ASX: ERA) and Paladin Energy (ASX: PDN) are two producers that rose phenomenally in that three-year space before the GFC hit. Paladin became a producer in 2006, but you still had a chance to pick it up at $2.00 before it hit $10.00 in 2007. Energy Resources Australia went from $2.00 to $18.00 in that period. Now both are trading under $2.00.
Their financials tell a different story. Paladin hasn't turned a profit in the past 10 years. ERA was steadily growing a profit until 2009, when uranium first came crashing down. ERA has no debt, a strong current ratio (current assets/current liabilities) and is 68% owned by Rio Tinto (ASX: RIO), and having a strong connection with Australia's second largest miner is a great advantage when it comes to access to necessary skills and technology.
Before the GFC, the mining industry was talking about the "super cycle" that would go on for a decade or more because of the development of China and India. That was interrupted, but the basic resource needs didn't disappear, they've only been delayed because we still have business cycles along the way.
Uranium is a sagging sector in the current downtrodden mining industry — it produces a radioactive material that many people oppose even using, and it's sold at a deflated price. Buying into ERA now would be counter-cyclical. Buying at a discount when uranium prices are depressed, and riding it out until the demand outstrips supply is the way to a higher share price and return.
Foolish takeaway
"Hunting for roses in the desert" can pay off when others are put off by the unattractive features of a company. By the time the demand really picks up, the ore price will already have risen. Buying in gloom and selling in boom still works. Stick to real producers which are the best in their industry, and they will act as the proxy for increasing uranium prices.
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Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned.
