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Stock: Energy Resources of Australia

Stock code: ERA

Share Price: $7.76 (as at Friday 1st April, 2011)

Broker buys: 

Alto Capital (28/3/2011, share price was $8.31 that day)

Chart: Share price over the year to 01/04/2011 versus ASX200 (XJO)

The expression “timing is everything” must still be ringing in Phillpe Jabre ears.  The $6 billion dollar hedge fund manager of Jabre Capital Partners bought Japanese stocks immediately after the earthquake and subsequent tsunami hit Japan. As the nuclear disaster intensified in Japan, Jabre’s fund lost $300 million as he exited his positions only to see the markets recover as the Japanese government intervened to stabilise its financial system. Ouch.

Hysteria led sell-offs offer contrarian investors the chance to make big money as fear subsides and investors realise the world isn’t over. That being said, contrarians need to learn from the experience of Mr. Jabre and tread lightly when considering these opportunities. Uranium companies such as Energy Resources of Australia may be seeing a once-in-a-generation shakeout and bargain buying opportunity as the world reconsiders nuclear power as a viable energy source.

Company Description

Energy Resources of Australia is one of the largest uranium producers in the world, providing around 10 per cent of global uranium production. ERA mines uranium ore and produces drummed uranium oxide at its Ranger mine, 260 kilometres east of Darwin in Australia’s Northern Territory.

ERA sells its product to power utilities in Asia, Europe and North America under strict international and Australian Government safeguards.  Rio Tinto owns 68.4 per cent.

Financials

Earnings

2010 was a difficult year for ERA. Net profit after tax was $47 million, down from a record of $273 million in 2009. EBIT also dropped in 2010, $48 million versus $375 million. In 2010, underlying earnings excluded a one-off charge related to the write-off of previously capitalised expenditure for a trial water treatment process project, which was discontinued after the results of the trial did not meet the expected performance.

Revenue

Revenue from the sale of uranium was $572 million, a decrease of $196 million when compared with a record of $768 million in the prior year. The drop in sales in uranium oxide was due to lower sales volumes resulting from reduced production, as well as a lower average realised sales price of uranium and the strengthening of the Australian dollar against the US dollar. The lower average realised sales price of uranium for the year was largely due to a decline in global long-term market prices.

Dividends

ERA decided that a final dividend for 2010 will not be paid versus a 2009 final dividend of 25 cents per share; an interim dividend of 8 cents per share compared to 2009 interim dividend of 14 cents. The total dividends payable to shareholders for the 2010 year was 8 cents per share, fully franked versus a 2009 total dividend of 39 cents per share.

Valuation

ERA’s market capitalisation is $1,526 million based on a closing price of $7.99 and 190.7 million total shares outstanding.  Current trailing P/E is 24.61 compared to 22.86 for its industry. Using analyst 2012 EPS forecast of 86.1 cents and a multiple of 18 based on ERA historical earnings growth, historical margins and risk profile, ERA can be valued approximately around $15.50.

Uranium Macro Picture

As global growth continues to improve, emerging market countries are seen as the driving force for greater energy demand.  Emerging economies that are rapidly developing need to expand their power grids to provide for the basic needs of their growing populations.

Since September of 2010, uranium shares have soared as emerging economies expand their next-generation state-of-the-art nuclear reactors. Nuclear has been viewed as a critical element to provide clean and efficient energy for many developing countries.

Countries in Europe and the Middle East, as well as India, Russia and the U.S. are planning nuclear energy development. In many countries is not just about building new reactors, but replacing old inefficient plants. The United States alone has over 100 reactors, where many are aged and need upgrading.

China, India and Russia have 42 reactors currently under construction, another 82 planned and 210 proposed. China is in the process of trying to acquire many resources including uranium from Australia.

Uncertainty In the Uranium Market

There is considerable uncertainty for investors in uranium stocks at present. Last week that the Chinese government announced that it is putting on hold approvals for proposed plants, and is reconsidering long-term plans for 28 new reactors, or 40 percent of all those being built worldwide. Before the disaster in Japan, China’s demand for uranium was projected to grow 44 per cent a year to reach 18,000 tonnes by 2016. China’s State Council also ordered relevant departments to make emergency safety checks at existing nuclear plants.

Political pressure is building in Germany as well. Germany has shut down seven reactors built in the 1980s for safety checks in response to the crisis.

Technical Picture

The short and longer-term charts are not very pleasing for ERA bulls. 

Taking a look at the 3-month daily chart of ERA, you can see that since mid December 2010, ERA has been in a down trend – clearly defined by the series of lower highs and lower lows made on the chart. 

Examining the daily chart, technicians may see that ERA appears to be breaking out of a bearish wedge continuation pattern.  Using the wedge pattern to project short-term price movement, ERA appears to be headed back down to the 7.00 handle.  In order to find any potential support levels we need to take a look at a longer-term chart.  Bulls will take little solace looking at this long-term chart that goes back to 2003. 

The broader technical picture suggests that if ERA cannot retake the 9.50 and 10.00 level then move a back to February 2004 level may be in the cards.  

Current fundamentals wouldn’t justify a move that low, but one has to wonder how far the current negative sentiment in the market could drive ERA shares.  Just as market participants have a tendency of becoming overly optimistic, they also have a tendency to drive shares excessively lower when bearish.

Analysts

Brendan Fogarty of Alto Capital who has a buy recommendation on Energy Resources of Australia recently commented:

“Operating in the Northern Territory, ERA is currently the world’s fourth biggest uranium producer. The shocks from Japan appear largely factored into heavy price falls across the uranium sector. Uranium prices are likely to trade at $US60 a pound – the lower end of most analyst estimates.  Global medium term demand for new reactors still exists.”

Conclusion

With all of the negative sentiment regarding the future of nuclear energy, one has to be careful choosing which uranium producers to buy. 

With shares down 57.4 per cent over the last 12 months, Energy Resources of Australia will be on the radar of many contrarian investors. 

ERA’s technical picture suggests that investors need to be extremely cautious when deploying capital.  Timing the bottom is a difficult task at best as Phillpe Jabre can attest to.