Centrus Stock: A Cheap Way to Play Nuclear Power (NYSE:LEU)
Regular readers know that I am optimistic about nuclear power as the solution to our energy crisis. Not only does it produce near-zero carbon emissions, nuclear power is also vital to our energy security. I detailed some of my bullish arguments in my articles on the Global X Uranium ETF (URA).
I recently came across Centrus Energy Corp. (NYSE: LEU), a company a bit different from the uranium miners people are more familiar with.
LEU has the only deployable US centrifuge that can enrich uranium for utilities in North America and other allied nations. Its margins are currently benefiting from higher prices for enrichment services, as well as recently renegotiated uranium supply contracts. I think investors can consider hoarding stocks, although there is headline risk from possible Russian sanctions.
Centrus Energy is a major supplier of nuclear fuels to North American, European and Asian utilities.
Centrus operates in two business segments: Low Enriched Uranium (“LEU”), which provides nuclear fuel to commercial customers, and Technical Solutions, which provides engineering, design and manufacturing services to governments and to private sector clients.
Centrus’ LEU segment plays a role in nuclear fuel cycle nuclear conversion and enrichment and provides the majority of the company’s revenues and nearly all of its profits (Figure 2).
Centrus’ LEU segment derives its revenue from the sale of separation work units (“SWU”, a standard unit of measurement representing the effort to transform a given amount of natural uranium into enriched and depleted uranium) and natural uranium components of LEU.
Russia’s invasion of Ukraine dramatically increased the price of SWU, as Russian enrichment facilities were effectively taken off the market (Figure 3).
At the same time, Centrus’ uranium supply was locked in near the lowest uranium prices a few years ago, so Centrus currently enjoys favorable margins in its LEU business segment.
The image of the extended margin appears in Centrus’ financial statements. Figure 4 is a condensed financial summary from Centrus, showing the dramatic improvement in earnings.
Note that the 2021 and LTM results include a $44 million settlement of claims related to the reimbursement of retirement and post-retirement benefits from prior work. This settlement is recorded as revenue in the Technical Solutions segment and represents approximately $3/sh in pre-tax profit.
On an adjusted basis (removing the revenue and operating profit settlement), operating profit for 2021 and LTM would have been $92 million and $123 million, respectively, or an operating margin of 36 % and 45%.
With a current market capitalization of $680 million or an enterprise value of $718 million, Centrus trades at an adjusted LTM P/E multiple of just 7.4x (assuming LEU pays no current taxes, as explained in the next section) or adj. EV/EBITDA LTM of 5.4x. Both metrics highlight Centrus’ cheap valuation.
Deferred tax assets worth $28/share
From Figure 4 above, we see that historically UFE has not had significant tax burdens. The reason for this is that the economics of the fuel enrichment business had been poor and Centrus had accumulated hundreds of millions in deferred tax assets (Figure 5). However, due to the low profitability, LEU had to discount the deferred tax asset with a large valuation allowance (because it was uncertain whether the deferred taxes could be used in the future). In Q4 2021, with improved profitability, Centrus was able to release $41 million of its deferred tax deduction, which effectively added $2.80/sh to 2021 and LTM earnings.
As Centrus continues to post improved earnings over the coming quarters and years, we can expect further releases from this provision account. The total valuation allowance of $415 million is worth $28.40/share.
Russian supply risk
The biggest risk to Centrus’ story is its Russian supply of enriched uranium. Currently, Centrus imports a significant portion of its uranium from Russia under the “TENEX Supply Contract”. Although Centrus has several sources of supply, including a long-term supply agreement with French nuclear conglomerate Orano, the company noted in the risk section of its annual report that:
If any action were taken to limit the supply of Russian LEU or to prohibit or limit transactions with Russian entities, including but not limited to TENEX or ROSATOM, the Company would apply for a license, waiver or other government approval imposing such measures to ensure that the Company can continue to meet its purchase and sale obligations. There can be no assurance that such license, waiver or approval will be granted. If a license, waiver or approval was not granted, the company would have to look to other sources of LEU to replace the LEU it could not obtain from TENEX. The Company has contracts for alternative sources that could be used to mitigate some of the short-term impacts. However, to the extent that these sources are insufficient or more expensive or if additional supply cannot be obtained, this could have a material adverse effect on our business, results of operations and competitive position.
In fact, at the start of Russia’s invasion of Ukraine, Centrus Energy’s stock price actually fell to a low of $17/share because there was talk of d possible US sanctions against Russian nuclear energy or ROSATOM (Figure 6). Although LEU stock price has rallied, the stock is still very sensitive to potential headlines about Russian nuclear sanctions.
Centrus Energy is an interesting way to play up the theme of nuclear energy via the enrichment of uranium fuel. Centrus has the only ready-to-deploy US centrifuge that can enrich uranium for utilities in North America and other allied countries. He is currently seeing improved margins thanks to the rising cost of uranium enrichment. I would recommend investors to hoard stocks, although there is a risk of Russian sanction, as much of the uranium in UFE comes from Russia.