Small-Cap Special Situations
Buying scarcity is usually a good idea. Beachfront properties, mint condition coins and limited production automobiles all testify to the enduring value of scarcity. But sometimes scarcity is temporary, especially in the commodity markets. For months or years at a time, demand will swamp supplies of a given energy product or metal or grain.
Eventually, however, production catches up with demand and scarcity yields to excess.
As investors, we should always be on the lookout for scarcity, whether that scarcity be enduring or temporary. Scarcity creates opportunity, as my anecdote below illustrates…
I just returned from a weekend of camping in Pennsylvania. There was a pile of newspapers waiting for me. Lots of stuff in the mail too — newsletters, research, magazines and more. The e-mail box was even more loaded. Amazing what happens when you’re gone even for only a few days. So today I’m easing back into the routine.
First, after quickly digesting the pile of newsprint in front of me, I wrote up a quick comment for my Capital & Crisis readers.
Usually, I’ll pick out what I think is the most compelling story of the day — one that also ties in with what I’m doing in my investment letters. There is always something going on somewhere that makes me sit up and go, “hmmm.” Lots of times I don’t even know where a story might lead. Investment ideas don’t usually leap off the page and grab me around the neck. More often, I just clip out bits and pieces of things of interest and file them away in my office. After awhile, certain threads and themes emerge. Sometimes an actionable investment idea comes out of all of this.
Today’s piece is about China’s massive plan to build many more nuclear power plants. China’s nuclear ambitions stagger the mind: $50 billion and 32 plants by 2020. The “whisper” number of 300 more by the middle of the century is even more mind-blowing.
Something of a nuclear renaissance has been in the works for some time now. Perhaps the best testament to that fact is the price of uranium. In 2004, the price of a pound of processed uranium ore was only $14.40. Today, it’s more like $120. You might think the soaring uranium price would put a brake on new plants. But that’s obviously not the case.
One of my camping buddies works for the Department of Energy. He oversees several research projects related to nuclear power. Over a campfire one evening, we chatted about the nuclear renaissance.
When I mentioned the price of uranium, he said there was plenty of uranium. “We know where it is,” he said. “We can make the Australians very rich, like the Saudis with oil.”
The Canadians produce quite a bit of it, as does Kazakhstan. The problem is that there is not plenty of uranium right now.
There are about 4.7 million tons of identified resources of uranium that companies can mine for less than $60 per pound, according to a recent report from both the Organization for Economic Cooperation and Development and the International Atomic Energy Agency. “At 2004 nuclear generation rates,” the report states, “that would be enough [uranium] to supply the world’s reactors for 85 years.” But uranium in the ground is not the same thing as uranium at the power plant. It takes time to build a new mine, especially when the world’s largest uranium producer, Australia, continues to impede the development of new mines.
So uranium prices might continue climbing for several more years, especially because higher prices are unlikely to curb demand. Even at $100 a pound, uranium is not a huge component of the cost of nuclear powered-energy. “Fuel accounts for only 26 percent of the production cost for nuclear-generated electricity,” the Nuclear Energy Institute (NEI) explains. “In contrast, fuel accounts for more than three-quarters of the cost of coal-, gas- or oil-generated electricity.”
This pricing advantage is one reason why nuclear energy is relatively cheap. “U.S. nuclear power plants have the lowest production costs of any large-scale source of electricity, except hydroelectric,” the NEI continues. “In 2005, the production cost for nuclear-generated electricity was 1.72 cents per kilowatt-hour (kWh), compared with 2.21 cents per kWh for coal, 7.51 cents for natural gas and 8.09 cents for oil.”
So even if uranium prices double over the next few years, nuclear energy would remain an extremely competitive energy source. Eventually, of course, new uranium mines will come on line. And eventually, of course, the price of uranium might retreat. But so what; the price might soar in the meantime, especially because demand seems certain to increase sharply.
Only 103 reactors are online in the United States right now. But these plants deliver about 20% of the U.S. energy supply. France is the leader, getting nearly 80% of its power from nuclear reactors. But many other countries get a third or more of their power from nuclear plants. China, ironically, is near the bottom: 2.3%. Given what China’s demand for other commodities has done for the prices of those commodities, we should take note of its new surge into nuclear power. It would seem to bode well for the price of uranium and the profits of those who sell it.
I’m not saying investors should run out and buy uranium-mining stocks. Those stocks have had a great run already. I’d say it would be hard to find a “hidden gem” in that lot. But I’d also say that the uranium bull market has probably not run its course. Uranium, however, is not the only scarce resource in the nuclear energy market at the moment. Skilled labor is also scarce.
I told my friend about what I had read about the lack of nuclear physicists and other qualified scientists in the field. Most are either very old or very young. There was a long time when the nuclear industry was dead and few wanted to go into the field.
He agreed with me and pointed out that two of the most valuable employees in his department are both over 70 years old.
For about a year, I followed a company called Washington Group International (WNG: NYSE). The company had a niche in nuclear power and many qualified people on its payroll, not to mention an accumulation of institutional knowledge gained over the years.
I came very close to recommending this company several times. In late May, I noticed that URS Corp. bought the company. So the stock is up more than 45% since I put it on my watch list about a year ago. I’m sorry I missed that one. But this buyout speaks to the growing need for experts on nuclear issues…and also to the value of scarcity.
The shares of Washington were never cheap on the basis of their earnings. But URS bought out the company anyway, apparently because nuclear expertise is very scarce at the moment, and therefore, very valuable. When I give a casual glance at the companies I’ve recommended to the readers of Mayer’s Special Situations, focusing specifically on the companies that benefit from some kind of scarcity, one small-cap stands out.
Talk about unique assets and scarcity! This company owns acres of valuable farmland in Argentina and the know-how to vastly increase the yield and productivity of its farms. Not much has changed from my original write-up and it remains a good long-term holding.
Somewhere, sometime on this big blue globe of ours, there are assets of a kind in short supply and high demand. Finding assets that are scarce and likely to get scarcer — and not paying too much for them — is probably not a bad investment formula.
October 8, 2007
P.S.: As I mentioned, this Argentinean farmer could be the biggest find I’ve made since I recommended Lindsey Corp, which is a small-cap irrigation systems manufacturer, to my readers. The Argentinean farming company is still under my buy-up-to price, so you can still get in on it, as well as many other picks. But, you have to hurry… It is ready to take off.
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