Why Massive Upside Potential in Cameco Corporation Outweighs Short-Term Risks

Here’s why long-term investors should buy Cameco Corporation (TSX:CCO) (NYSE:CCJ) right now.

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The Motley Fool

Cameco Corporation (TSX: CCO) (NYSE: CCJ) is one of the most unloved commodity stocks on the planet right now, but value investors who have done their homework realize there is massive upside potential in Cameco’s shares.

Here are the reasons I think long-term investors should be looking at the future of the uranium industry with stars in their eyes and seriously consider Cameco Corporation for their portfolio.

Global uranium supply to get tight

The current oversupply situation in the global uranium market will likely continue in the near term, and this is why the market hates the shares of Cameco Corporation. Beyond the next 18 months, however, things could change radically — and this presents an opportunity for investors.

In 2013, world uranium consumption was about 167 million pounds but production of new product (primary supply) was only 156 million pounds. The 11 million-pound difference was supplied by uranium sources that were already sitting in stockpiles around the world (secondary supply).

The Russian Highly Enriched Uranium (HEU) agreement has been the main source of secondary supply for a number of years, adding as much as 24 million pounds to the market. The HEU agreement ended in 2013, and secondary supplies are already decreasing around the globe. The low prices in the market have meant new projects have been postponed or shelved completely because the numbers don’t justify the capital expenditures.

Mining uranium is a long-lead process and bringing new production online can take seven to 10 years. At some point in the next few years, there is going to be a huge supply gap and this is why investors should consider buying Cameco now.

Uranium demand will increase

Nuclear energy will continue to be a major source of electricity production around the globe. Cameco expects 90 net new global reactors to come online in the next 10 years as countries such as China and India scramble to meet growing electricity demand.

Japan will also be forced to restart the majority of its reactors. Despite the pushback from the Japanese public, the reality is that the country cannot afford to mothball every nuclear power plant. The economics just don’t support it as Japan is already struggling with elevated power bills due to the high cost of liquefied natural gas now being used to produce the country’s electricity.

Japan’s Sendai 1 and 2 reactors will probably be running again by the end of 2015. JP Morgan stated in a July 28 report that it expects Japan to restart 31 of its 48 operable reactors by 2019.

In its Q2 2014 earnings statement, Cameco said annual global uranium demand is expected to increase from 170 million pounds to 240 million over the next 10 years. Given the current cutbacks in project development and the long lead time required to start new facilities, uranium prices should increase significantly as supplies get tighter.

One risk to watch out for

Buying Cameco is not without risk. The company, which is currently fighting a tax battle with the Canadian Revenue Agency (CRA), has already set aside $215 million, or 50% of the disputed amount, as required by the CRA plus an additional $76 million.

Though the company expects to be successful in its dispute with the CRA, it acknowledges that a negative result “could have a material adverse effect on our liquidity, financial position, results of operations and cash flows.” If the CRA wins the case, Cameco will probably cut or eliminate its dividend. The current dividend is $0.40 per share and yields just under 2%.

The bottom line

For long-term investors looking at the potential for big gains, the opportunity in Cameco is quite compelling at current levels. The biggest reason to buy is the undeniable demand fundamentals moving forward for uranium and the probable supply shortage the market will face.

A favourable decision in the CRA case or a faster restart in Japan could be the catalyst to launch the shares higher in the near term.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Andrew Walker has no position in any stocks mentioned.

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