Saturday, August 29, 2009

Strathmore Minerals

One of my stock holdings Strathmore Minerals (STM.V) just became somewhat more enticing. STM is a Uranium miner with properties in Wyoming and New Mexico. They have some good properties and excellent people and management.

One of my beliefs is that if you can't explain why an investment is a good idea with a simple explanation, it probably isn't such a good idea.

So here goes. STM owns land with about 150 million lbs of recoverable Uranium (hereafter U308) resources. The sales price (long term contract price, not spot price) of U308 is about $70/lb. STM's operating costs are likely to be about $20/lb since it can extract the uranium with either open pit mining or the in-situ leaching (ISL) process. No complicated underground mines required. STM purchased most of this land when U308 was only $7/lb to $15/lb and claimed that it would be profitable to extract the U308 at about $20/lb. They correctly predicted that the price would rebound.

So the operating profit might be about $50/lb.

There are about 72 million common shares. The stock price is about $0.52/share. My first purchase was at $0.20/share in March 2009. Market cap is therefore $37MM.

So a VERY rough estimate of the value (assuming all the U308 is extracted at a $50/lb profit) is 50*150 = $7500MM. Note that this is 202 times the market cap. Now, this may be an over estimate. There is no guarantee that U308 price will not fall or that operating expenses will not be higher. But even if you take $40/lb for a selling price and $30/lb for an operating cost, you get a value of $1500MM. Now, maybe discount that by a factor of three to take into account the time required for the cash flows to arrive and the risk. You still get a present value of $500MM or 14 times the market cap.

Basically the stock is priced as if the U308 will never be extracted. Actually it is priced as if it is ALMOST CERTAIN that the U308 will not be extracted. That is, even if the U308 price was so low that STM could not extract it profitably, the company should have option value just like an out of the money call option. That is, there is always a chance that the U308 price will sky rocket to say $100/lb (where it was just last year) or higher.

Another risk is that they can't raise the capital required to extract the uranium. I have never worried much about this risk. If there is money to be made, capital seems always to be available. The company already sold a 40% stake in their New Mexico, Roca Honda properties to Sumitomo, the Japanese conglomerate for $50MM. There is about 33 million lbs of U308 in Roca Honda or about 20% of their total resources. That would value that entire asset at $125MM or $3.75/lb of U308.

Remember the market cap of the whole company is only $37MM. Valuing it all at the price Sumitomo payed would be $562MM or 15 times higher.

Very recently, they sold another asset, Pine Tree & Reno Creek that holds about 20 million lbs. They sold it for $30MM in cash or $1.5/lb. Valuing all their U308 resources at this price would be $225MM or 6 times the market cap. But this is likely a very low price. They sold this land because they needed the cash to start operations on some of their core assets. The deal has not been finalized. It depends on the buyer obtaining financing. But if it goes through, they will have $30MM in cash. Cash should always be valued at full value on the companies balance sheet. So subtract $30MM from the market cap of $37MM and you have an Enterprise Value of only $7MM. It is costing you only $7MM in net cash to buy the whole company which will still have 120 million lbs of U308. Even if you only value the U308 at $1/lb, it is worth $150MM.

So there you have it. Now matter how you slice it, the company is worth many times it market cap. If you get lucky, the U308 price will remain high or go higher and the company will be worth a fortune. If the U308 price falls a lot, it still seems worth the current price even if the recent deal falls through.

Very little risk and the chance for enormous gains makes STM currently one of my favorite investments. I am glad I bought at $0.20/share but will be adding more at the current price.