How safe is your money in Paladin Energy Ltd?

If you're going to invest for the long-haul, make sure you're backing the right horse.

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When looking at the steady downward trajectory of the S&P/ASX 200 Energy index over the last 10 years, it can be tempting to start thinking with a contrarian mindset in a search for bargains.

Of course, there are share prices of stocks that are materially down in recent years, companies such as Santos Ltd (ASX: STO) Woodside Petroleum Limited (ASX: WPL), and Origin Energy Ltd (ASX: ORG). And then there are those stocks that have completely bombed.

One such stock is Paladin Energy Ltd (ASX: PDN).

Paladin Energy is a company that explores for and produces uranium, and has its main projects in Australia, Namibia and Malawi. Paladin also holds the rights to an area in north-eastern Canada which is considered by Paladin to be highly prospective.

Naturally, being a producer of uranium – more technically known as Triuranium octoxide (U3O8) -Paladin's economic performance is almost completely aligned with world uranium prices, which can be seen here.

It's no wonder then that Paladin's boom/bust stock performance looks so similar and is graphed below:

Source: Westpac

Of course, as can be seen from above, a lucky trader could have bought these shares at a fraction of a cent and then proceeded to sell them at a price well north of $9 in mid-2006. Hindsight though is quite useless for those investors who need to know what to do today.

At The Motley Fool we're all for buying and holding company shares for the very long term, but there's one important caveat here: you need to pick the right horse to back before deciding to embark on such a buy-to-hold investment strategy.

Long-term shareholders who have held all the way through since Paladin's listing on 24 September 1993 have, unfortunately, endured a compound annual growth rate of a mere 2.75%. Given average weekly ordinary times earnings (AWOTE) and the consumer price index (CPI) have averaged 4.12% and 2.36% respectively over this time period, this is a disastrous result.

(By the way, the last 10 years have produced a result of -26.2% pa which is probably due to the fact it's only once reported positive earnings (in 2008-09), the number of shares on issue has more than tripled, and its debt levels have exploded).

So, given the bombed-out share price and the recent share market performance of the energy sector as a whole, is it worth buying shares in Paladin today?

Currently, there could be a few reasons for buying shares:

  • First, Paladin's of the view that the current low prices of U3O8 will constrain supply. The thinking is low prices will force producers to curtail mining as current production proves uneconomic.

The unfortunate irony for Paladin though is that in May of 2014 processing at its Kayelekera mine in northern Malawi 'temporarily' ceased due to the sustained low uranium price and would not recommence until the price increases to around US$75/lb – a long way from the current price of US$26.50/lb.

  • Second, demand is rapidly accelerating in new markets (the 'BRIC' countries mainly) as their reliance on nuclear power increases as a proportion of their overall power generation.
  • Third, countries such as Japan that previously reduced their reliance on nuclear power are now (re)opening their nuclear reactors.

Perhaps the juiciest, but riskiest, reason for wanting to buy Paladin shares though is the talk of a takeover by China National General Nuclear Corporation and China General Nuclear Corporation.

Foolish takeaway

In my view, buying shares to be bought out by a suitor is a speculative course of action and I don't actually recommend anyone buy shares for this reason alone.

As for the other three reasons, I don't think they mitigate Paladin's extremely poor business performance and I'm not willing to give management the benefit of the doubt in this instance.

This leaves the economic fundamentals relative to price as the sole criterion for deciding whether or not to buy shares.

Given the company's very poor returns, I would avoid Paladin's stock for investment. It also proves that not every stock can be bought with the intention of holding for many years.

If you are going to implement the buy-to-hold investment strategy, at least make sure that your company's economic performance is satisfactory which, clearly, Paladin's has not been and is not likely to be in the future.

There are a lot of stocks on the ASX which don't need to be bought and this is definitely one of them. Avoid.

Motley Fool contributor Edward Vesely has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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