Bannerman Energy Ltd BNNLF

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/www.theenergyreport.com/">The Energy Report 02/17/2011

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uranium equities remain alarge portion of your coverage universe. Could you tell us about theinstitutional investor appetite for uranium equities now and over the last fourto six months?

Ed Sterck: Well, it's certainly picked up. When you look back 12 months,the uranium market was pretty uninteresting for the average institutionalinvestor. Prices had remained fairly flat until about six months ago. Sincethen, obviously, the spot price of uranium has picked up markedly and withthat, we have seen a return of investor appetites for uranium plays. I thinkthat's slightly precipitated by people's recollection of the price spike of2006–2007, and the response that company share prices demonstrated with theprice spike. I think it would be fair to say a number of the investors lookingat uranium again are hoping something similar will unfold.

TER: Are you seeing an increase to the $130/lb. range as was the case in2007?

ES: My analysis is a little more subdued than that. I actually thinkthat uranium supplies will be adequate for the next several years, and thenenter into a deficit at the end of the current decade. If you were to look atthe supply and demand picture as I see it, then I would expect the price to bedetermined by the marginal cost of production. On that basis, I am looking fora price of $60/lb. in real terms for the next couple of years, and then alittle peak at $70/lb. in 2013 and 2014 before coming back to a long-term priceof $60/lb. That said, the uranium market is small and very sentiment driven.So, there's certainly the potential for a price spike, perhaps regardless ofthe underlying fundamentals.

TER: You talked a little about institutional investors' growingappetite. Is there anything different about the types of investors entering themarket this time around? Have you noticed anything unusual?

ES: No. I think it's a similar collection of people, though thegeneralist funds are looking at the uranium space at the moment. But I thinkthere is a difference in the way investors are looking at each of theindividual stock opportunities, certainly in terms of those companies that wereexploration and development plays back in 2006–2007. Many of those companiesare now in production, and I think there is more of a focus on companiesproducing meaningful amounts of cash flow. So, rather than just buying thosestocks on the basis that the uranium price might go up, I think investors arebeing selective about which stocks they choose, expecting some stocks toactually have a great return for shareholders on a peak-cash flow basis.

TER: So the last run-up in uranium prices funded a number of projects,and the investors that got out of those stocks when uranium fell to below$40/lb. are coming back. But many of those projects are in production or cominginto production and generating cash flow. So, those projects are far lessspeculative.

ES: They are probably far less speculative than they were in the past.What I was trying to angle at is that I think people were a bit less discerningabout which stock they invested in back then—like anything with"uranium" in its name was worthy of investment given the pricerun-up. Now, investors are saying, "Okay, I expect this stock tooutperform that stock on the basis that it's going to generate meaningful cashflow, whereas the other is going to struggle to give a decent return toshareholders."

TER: Do you think that's directly as a result of what happened in 2008?

ES: I think you've raised a good point there, and I think that itprobably is. Some investors did get their fingers burned last time and perhapsnow they are being a little more cautious. You know, once bitten, twice shy.

TER: What are some companies that you expect to generate solid cash flowthat discerning investors are taking a closer look at?

ES: Well, one of the problems is there's a limited selection ofpure-play listed producers out there—there aren't many options. Look at thebiggest companies, like Cameco Corp. (TSX:CCO; NYSE:CCJ),the share price of which has performed extremely well over the last six monthsor so. Cameco sells its uranium production into a contract book, so it has lessexposure to the uranium price than some of the other producers. Consequently,it might make less for an investor than some of the mid-cap producers. On theother hand, given Cameco's size and liquidity, it might be the only option forthe generalist funds coming into the space. We look a bit further down the foodchain, toward the mid caps that will demonstrate a great amount of growth incash generation.

TER: What are some of those mid-cap names?

ES: One example would be Paladin EnergyLtd. (TSX:PDN; ASX:PDN). It was anexploration-development play back in 2006–2007, and it now has two mines inproduction. It's running into a few difficulties but, over the next couple ofyears, it should have a stronger production growth profile than Cameco. So, onewould suspect—coming from a small base, of course—that the relative improvementin cash flow will actually be greater than Cameco's.

TER: You said in a recent research report that Paladin looks fullypriced and is receiving a market premium formanagement and mergers and acquisitions (M&A) appeal. Do you seeconsolidation on the horizon in the uranium sector, or is that a little fartheroff?

ES: No, I think that will be one of the big themes this year, though Ianticipate it will be the large- and mid-cap guys consuming some of the smallercompanies with good projects. One recent example would be Paladin buying AuroraEnergy Resources, Inc. from Fronteer Gold Inc. (TSX:FRG;NYSE.A:FRG). There are some political risks associated with that particularproject, but that's the kind of transaction I expect to occur.

In terms of the bigger companies, there might be acquisitions or a merger ofequals but I think both events are unlikely. For example, I think Cameco buyingPaladin is unlikely—I don't think Cameco could afford Paladin right now.Acquisitions of mid-cap companies are more likely to come from higher up thefood chain, perhaps by the power utilities, principally out of Asia, looking tosecure production. We're talking about companies like China National NuclearCorp. (CNNC) or China Guangdong Nuclear Power Co. (CGNPC) looking at a companylike Paladin and thinking, "China's got a very ambitious nuclear growthprogram, which will require uranium to fuel it. Rather than buying a projectand developing it ourselves, perhaps we should just go and buy currentproduction." I think that's really why Paladin has M&A appeal becauseit's the only one of the senior or mid caps that actually doesn't have asignificant minority shareholder or a shareholder with a potentially blockingstake.

TER: It probably wouldn't be all that strategic for Cameco to purchasePaladin's assets over some right in its backyard in the Athabasca Basin thatbelong to DenisonMines Corp. (TSX:DML; NYSE.A:DNN) or smallercompanies like HathorExploration Ltd. (TSX.V:HAT). If Cameco wants to see tangible appreciationin its share price, could it be looking at M&A activity in the basin?

ES: My feeling is that Cameco already has a big land resource in theAthabasca. But the market gets so excited about companies like Denison and itsWheeler River project, which is starting to look really interesting. However,the market has given such a big premium to Denison for Wheeler River'sexploration potential that Cameo might balk at paying the premiums currentlydemanded to acquire those assets.

Conversely, although it's not in Cameco's "backyard," buying assetsin Africa might not increase its geopolitical risk, strangely. For example,Namibia, where Paladin's project is located, is probably one of the mostmining-friendly regimes around at the moment.

TER: You mentioned Denison is receiving a market premium for the WheelerRiver project. But in a recent research report you said the premium on Denisonalso involves its M&A appeal. So, if it's notCameco, who would be looking at Denison?

ES: The other possible candidates out there include other mid-cap producersor even some of those power station organizations I mentioned. Of course, for anon-Canadian company to buy Denison, it would have to do so in conjunction witha Canadian company that would take a majority stake in the project because thatis required under Canadian law.

TER: Denison recently said it would produce 1.2 million pounds (Mlb.) ofuranium oxide this year. In your research, you said Denison's particularlysensitive to uranium price rises. Is that guidance in line with what youthought it would be?

ES: I think the guidance the company gave was a little better than I hadanticipated, but it's such a small amount of production that it isn't a reallybig driver of the stock. The stock value is driven by its exploration portfolioand the market's expectation for Wheeler River rather than earnings fromuranium sales.

TER: Why is Wheeler River so important to the company?

ES: Given that Denison's current production is a relatively smallcomponent of its valuation, its exploration projects are the main value driver.If we take a step back, projects in the Athabasca Basin tend to be very small,very high-grade deposits. As a consequence of their small size, they can bevery difficult to find through geological exploration. So, an awful lot of moneymust be spent to make those discoveries, and for most companies that work willamount to nothing.

One of the reasons that Wheeler River is interesting is because Denison hasencountered high-grade uranium in a large alteration halo, but it's also findingthat the high-grade mineralization continues as the company drills farther awayfrom the initial discovery. On top of that—and I think this is as interestingas the resource Denison has defined to date—the geological situation of the orebody is very analogous to Cameco's McArthur River deposit, which is one of theworld's largest uranium mines. If Denison has something similar to that, itcould be very appealing for the company indeed. However, the timeline toproduction even for a really interesting project like McArthur River is between10 and 20 years. Even if Denison has found something really exciting, we'restill a long way from seeing any uranium production even if it determines it'san economically viable deposit.

TER: Let's talk more about M&A activity. Do you expect that to begeographical in nature? Or should we look for more diversification in terms ofexposure to uranium in a given locale versus another?

ES: Well there are a limited number of countries in the world that haveeconomic uranium deposits at the current uranium price. Probably what we'll seeis more people looking to acquire projects in areas that, in the past, facedpolitical opposition to uranium mining but now are allowing mining. An examplewould be Western Australia where there are numerous juniors with small- tomedium-sized deposits that might be available for a reasonable price. That'sone of the things we could see happening.

There's also some interesting exploration happening in places like Mali andBotswana. We could see people looking to pick up some exploration portfolioshoping to find a new uranium-producing district. On the other hand, I'm notsure the senior companies are prepared to pay any price for assets.Historically, M&A across all commodities tends to be fairly pricesensitive. If the market speculation that's building with the current increasein the uranium price translates into large market valuations for some of theseprojects, then they might not be that appealing to the seniors and mid-cap producers.

TER: But you're predicting $60–$65 uranium four years out, so it seemslike the price will be fairly static.

ES: Yes, but by using my assumptions for production and sales, I canroughly calculate the implied uranium price the market is paying for uraniumstocks. In most cases, it's significantly higher than the current uraniumprice. We're talking +$100/lb. for current producers and $60/lb. forexploration stocks, because the market's expectation is that uranium priceswill continue to rise. Exploration stocks imply slightly lower uranium pricesbecause the market is discounting development risk. However, if prices stay at$60–$65/lb. in real terms for the next four years, the market tends to getbored with things staying static, and I think we would probably see a reductionin those premiums. If I was a mid-cap producer with my price outlook—and Idon't think any of them share it—I would probably choose to sit on my hands andwait to pick up assets at a cheaper price.

TER: Has there been a noteworthy increase in uranium juniors seekingfinancing for uranium plays, or do you think there will be?

ES: We haven't seen a significant amount yet, but given the uraniumprice rise and increasing investor interest in the space, we'll likely see apick up in the number of juniors looking to capitalize on their higher shareprices in order to raise capital.

TER: One junior, Australian-based BannermanResources Ltd. (TSX:BAN; ASX:BMN; NYSE:BMN),recently completed a $15 million private placement at AUD
.50/share. Thatplacement was oversubscribed. Is that telling us more about the demand foruranium equities or Bannerman's prospects for further growth?

ES: I think it's telling us more about expectations for future uraniumprices than anything else. Bannerman is a company with a good management team;however, though its Etango Project is fairly analogous to Rio Tinto's(NYSE:RIO; ASX:RIO) Rössing mine, it suffers froma lower grade. In my mind, the oversubscription is an option on high uraniumprices. Investors are expecting uranium prices to continue rising; and forBannerman, based on my estimate, there will be athreshold price at which Etango makes sense. At that point, Bannerman's shareprice could reflect the improved project economics.

TER: In a recent research report, you said Bannerman basically needs$70/lb. uranium to show "appealing economic returns." However, youalso said management could accelerate development if things change. You have aMarket Perform rating on Bannerman right now. What do you expect from thatjunior in the short to medium term?

ES: Bannerman is in the process of finishing its feasibility study.Eventually, it will announce the study's findings to the market and how itproposes to go about developing the Etango Project. It wouldn't surprise me,though, if Bannerman accelerates the rate at which it's doing that work. Wecould get the results of that feasibility study sooner rather than later,probably around midyear.

TER: Have you visited Etango?

ES: I have, yes.

TER: What were you thoughts after your visit?

ES: From a technical perspective, it's fundamentally low risk becausethe style of mineralization is similar to the Rössing mine, which has been inproduction since the 1970s. It's really just the grade that's the issue. Ifuranium prices continue rising to the point that gradeis no longer the controlling factor, then the project could look prettyappealing.

TER: What sort of grade are we looking at?

ES: The current grade is around 220 parts per million (ppm).

TER: What would be considered high, or even average, grade?

ES: If we look at what they're mining in the Athabasca Basin, you've gotaverage grades there in the 18%–20% range. Now, compare that to ExtractResources Ltd.'s (TSX:EXT; ASX:EXT) Rössing Southdeposit, which it's renamed "Husab." That's considered to be a highish-gradedeposit for an open-pit target in Africa, and the average grade there is around470 ppm—that's 0.047% versus 18%–20% in the Athabasca. Although Athabasca Basindeposits are typically much higher grade than those in Southern Africa, theeconomic viability of the deposits can be fairly similar because you have fewertechnical challenges in Southern Africa than you might have in the AthabascaBasin.

TER: The deposits in the Basin tend to be smaller, too.

ES: In terms of total contained pounds, some of Cameco's are fairlysimilar but with the high grade, the deposits occupy a much smaller volume ofrock. The problem is, they're usually more than several hundred metersunderground and saturated with high-pressure water. So, in order to mine them,you have to freeze the ore body by pumping a high-saline solution through theore body at -35ºC. That adds to your costs versus an open-pit operation inSouthern Africa.

TER: Could you tell us about some other uranium names that are poised tobenefit from the current price environment?

ES: One of the other stocks would be Extract, which I already mentionedand which is one of my preferred stocks. Its Husab Uranium Project in Namibiais fairly analogous to Rössing South, so it should be fairly low risk. It doessuffer from a relatively large amount of overburden, which has to be strippedoff the deposit before it can be mined. But then it has the benefit of being asignificantly higher-grade than Rössing.

TER: Do you think Rio Tinto would take a run at Extract given theRössing deposit's proximity to Husab?

ES: Rio Tinto already has an effective 21% stake in the company,including an indirect stake through Kalahari Mineralsplc (LSE:KAH; NSX:KAH), which has roughly a 45%interest in Extract. I think if Rio Tinto were to take out Extract, it wouldalso have to buy Kalahari. That would be quite a difficult transaction for Rioto undertake. The company tends to be very conservative in the commodity pricesit uses for internal evaluation of projects and investment opportunities. If welook at the way uranium prices have behaved in the last five years, Rio Tintomay be using a moving average, which would put the uranium price down to the low-to mid-$40s. For Extract, the implied uranium price is on the order of $60/lb.,which might look too expensive for Rio Tinto currently.

TER: Are there any other companies you like?

ES: The only other significant producer is EnergyResources of Australia Ltd. (ASX:ERA), which isalready 65% owned by Rio Tinto. I don't see that as being a significant takeouttarget. ERA's share price has underperformed the peer group significantly overthe past 12 months due to a number of production issues that necessitated thecompany make spot uranium purchases to cover its contracted deliverycommitments. Australia is suffering from an extremely wet season, which hasresulted in ERA halting production for three months—something that's driven thestock price even lower. Although ERA is not having the easiest of times, itsshare price is now so low it might show some appeal on a relative-valuationbasis versus the peer group. Potential positive catalysts include the wetseason ending without the open pit being flooded and positive decisions on amove to underground operations.

TER: Please leave our readers with some of your thoughts on the uraniumsector in 2011.

ES: As you know, I'm pretty cautious on the uranium price outlook. As Imentioned, this sector is very prone to sentiment and, at the moment, sentimentis building toward the possibility of a price spike. I'm telling my clientsthis is not a sector that I anticipate pulling back significantly—unless theuranium price gets too far ahead of the underlying fundamentals. It might notbe a bad place to park any spare cash investors may have because they'reunlikely to lose a significant amount of money by investing in the space, giventhe current sentiment.

TER: Thanks for talking with us today, Ed.


PT2 Adding this article here,I hold no- BAN- GLTA