HyperNormalTimes

Written by our Director of Equity Advisory, Jeremy McKeown, the HyperNormalTimes provides in-depth and considered long-term commentary on major macroeconomic and market-shaping themes.

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September 14, 2021

Energy Transition Plays – Yellow Cake & Telecom Plus

Ultimate resource 

 

I have never held conviction about investing in the energy sector. Specifically, I have believed in Julian Simons’ view that the ultimate resource is human ingenuity which has succeeded in lowering the real cost of nearly every natural resource over the long term. This trend continues as green energy policies and regulations are increasingly adopted. However, as we move through humanity’s latest phase of its endless energy transition, some intriguing consequences are worth a closer inspection and offer up investment opportunities.

Electricity sparks  

 

As wind and solar become a more significant proportion of our energy mix, we expose ourselves to the ebb and flow of wind speeds and hours of daily sunshine. So far this year, we have seen the lightest everyday average wind speeds since 1961, and we can all attest to a distinct absence of sun. As a consequence, wholesale electricity prices rocketed to £540 per MWh this week. Before you check, this is about 10x the average daily price over the last decade.

Coal-fired

 

At times like this, we should rely on reliable baseload energy, an always-on and dependable supply source. To the surprise of most people, this is currently taking the form of burning coal. Last week the National Grid paid two of Britain’s standby coal-fired power stations £4000 per MWh to fire up at short notice, relieve the shortage and pollute our skies. Not very climate-friendly.

Nuclear politics 

 

Nuclear is the optimal source of baseload supply as we transition to a zero-emission future. However, it remains firmly in the politicians’ “too difficult box”. The UK is not an isolated case; it is not even the worst example of the de-emphasising of nuclear in its energy mix. Throughout Europe, countries are falling victim to the consequences of our rush to alternative energy while at the same time accelerating the closure, and slowing the new supply of nuclear power stations, none more so than Germany.

Goodbye Angela 

 

The uranium price has rocketed upwards in the last few weeks, which might suggest that the politicians are grasping the nuclear nettle. Perhaps, in an outbreak of common sense, Angela Merkel has decided to open up Germany’s nuclear power stations, mothballed since the Fukushima earthquake? There is no evidence this is happening, but things are likely to change, particularly when it comes to German politics.

Goodbye Angela 

 

The uranium price has rocketed upwards in the last few weeks, which might suggest that the politicians are grasping the nuclear nettle. Perhaps, in an outbreak of common sense, Angela Merkel has decided to open up Germany’s nuclear power stations, mothballed since the Fukushima earthquake? There is no evidence this is happening, but things are likely to change, particularly when it comes to German politics.

Under supplied 

 

Uranium is a fringe interest compared to mainstream energy resources, but altogether more fascinating. First of all, the price of uranium is a relatively small part of the cost of production. Second, there have been some exceptional conditions in the supply of uranium that have persisted for several decades. There is an active secondary market for uranium, principally strategic stockpiles held by governments and defence establishments. The world has been producing much less uranium than it has been consuming.

Fundamentals asserted 

 

It has been usual for uranium miners to buy uranium on the secondary market as a cheaper alternative to expanding primary production to fulfil long-term supply contracts with the nuclear power providers. However, this supply overhang is being depleted and is unlikely to fill the supply/demand deficit for much longer. Indeed the marginal cost of supplying newly mined uranium is closer to $60 per lb, some 50% above the current spot price.

Sprott spurt 

 

Canadian alternative asset manager has recently seized on this somewhat fragile market dynamic. Sprott runs alternative investment funds focused on precious metals and has newly acquired a fund called Sprott Physical Uranium Trust (SPUT). (As a word of caution, only search for #SPUT on Twitter if you have a free half-day, it is approaching #BTC proportions of content). The permanent structure of SPUT combined with the illiquidity of the underlying spot uranium market SPUT has driven it to a significant NAV premium. Sprott’s mandate allows it to issue units in SPUT whenever it trades above NAV, using the proceeds to buy more uranium. This positive market loop has spurred the spot uranium price from under $30 per lb to over $44 per lb in just a few weeks.

Cakeism 

 

Meanwhile, sitting in the depths of London’s AIM market resides a specialist investment company called Yellow Cake. Yellow Cake’s sole purpose in life is to own a stock of physical uranium. It has a unique supply relationship with Kazatomprom, the largest and one of the lowest-cost uranium producers globally. It can acquire bulk quantities of uranium for storage, allowing it to circumnavigate the spot market. Not surprisingly, Yellow Cake’s share price has followed the price trajectory of its underlying holdings in uranium, rising from a recent 250p to over 340p (40%). While SPUT is currently trading at a 30% NAV premium, Yellow Cake, capitalised at £450m and is supported by a spot NAV of about £450m, a 4.5% NAV premium.

Longterm upside

 

So, what is the investment opportunity here? The Sprot move into physical uranium has acted as a catalyst for repricing the uranium spot price to align with its long term fundamentals. However, it remains below the long term marginal cost of supply (estimated at $60 per lb), and if you look at the long term history of the uranium price, you will note that in 2006-7, the price hit $120 per lb. While I do not typically advocate chasing prices, this one still looks risked to the upside. I think it might be time to have your Yellow Cake and eat it.

Value play 

 

If uranium sounds a bit exotic and overheated for you, but you like the idea of playing the rising cost of energy over the coming period. In that case, I suggest it might be worth looking at Telecom Plus (TEP), which trades as The Utility Warehouse (UW). UW is a UK based multiservice marketing company that supplies gas, electricity, broadband, mobile, insurance and payment services to 900 000 customers in the UK. Its distribution model is along the lines of Avon or Tupperware. It doesn’t have stores or advertise but operates via word of mouth from its army of 45 000 self-employed distribution partners. The critical recruiting catalyst for new customers to the UW offer is a rising energy cost, mainly retail electricity prices.

Hibernation 

 

From 2010 to 2014, the TEP share price travelled from £3 to £19 in a period where it grew its revenues by 2.5x, a period immediately following the last significant spike in UK electricity prices.  This price spike led OFGEM to introduce the Standard Variable Tariff and a market structure that stimulated the entry of new independent electricity suppliers. A more competitive UK electricity market led to lower levels of customer recruitment into UW. In this slow new business growth period, UW successfully grew its customer retention by encouraging its distributors to cross-sell its other service offerings, improving its cash generation and return on capital metrics.

De'ja vu all over again 

 

It would appear like we are re-running the market conditions we last experienced in the late naughties in the last few weeks. Wholesale electricity and gas prices have spiked, and last week alone, the Guardian reported that two independent electricity resellers withdrew from the market. We also know that OFGEM has already sanctioned a 12% increase in the SVT from next month. All of which creates a newly revitalised recruiting ground for new UW customers.

Recruitment drive

 

Unlike the uranium price, the TEP share price is not currently in an upcycle. After peaking at £19 in 2014, the shares have traded between £8 and £15. At today’s £10 (plus change) the metrics are appealing. It trades on a current year PE of 17x, a FCF yield of 4.5% and a dividend yield of 5.5% and an EV/Revenue of less than 1.0. Homeserve, a similarly asset-light domestic services supplier, which has grown revenues quicker than TEP over recent years, trades on EV/Revenue of nearly 3x, yet achieves a lower ROCE. TEP has prepared itself for these times. Last weekend, UW launched its new Everyone Saves campaign at its first live event for its distribution partners in 2 years, which promises its new customers a minimum of £50 pa savings by switching to UW. TEP should benefit from the impending energy reflation trade as its distribution partners have a powerful new recruitment banner.

Jeremy

Ealing

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