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Friday, November 09, 2007

RCS Alert -- Denison Disappoints

Now for something a bit more painful. Recently, I recommended adding to the Denison Mines position in Red Hot Canadian Small-Caps. The company had earnings news this morning that was a disappointment to me ...

Denison Mines widens Q3 net loss to US$11.7 million from $6.4 million

The real disappointment is 2008 production, which I'll get to in a minute.

I talked to one of the company's executives in New Orleans, and his outlook for Denison was extremely positive. He focused on soaring prices for Vanadium, the outlook at the company's Tony M mine, and other bullish factors. He didn't express any potential disappointment in this quarter with existing operations, though he did say there was a delay in getting permits (everyone in the business is experiencing those delays). While I don't expect inside information, I do expect a level assessment of how things are going. Obviously, I didn't get that.

So, should we sell? Well, let's look at another company that had disappointing results this year -- Paladin ...
Paladin got caught in the big sell-off in uranium stocks in July/August. Then it had really disappointing news on production in September/October. As you can see, the pullback in uranium prices was more of a problem for Paladin than its falling production.

The two companies aren't exactly the same, of course, but here's what I expect from Denison: I expect it to sell off today. I expect it to find a new bottom. And I expect it to be higher a couple months from now.

Denison does have new production coming online. The problem is delays and other factors are slowing expected production increases. At the Tony M mine in the US, inexperienced crews and other setbacks are lowering the amount of ore available for processing in 2008. Denison now expects 2008 production to be 1.7 to 2.1 million pounds U3O8 and approximately 4 to 6 million pounds V2O5 (vanadium) as compared to previous estimates of 2.9 million pounds U3O8 and 4.0 million pounds V2O5.

The company's Arizona 1 Mine should also come into production in 2008, but won't supply much to start -- jut 60,000 tons of ore to the mill in 2008. 2009 should be much better.

The company's Midwest deposit is currently scheduled to commence production in 2011 and
production is planned to ramp up to a rate of about 9 million pounds per year with Denison's share being about 2,265,000 pounds per year. However, considering Denison's track record, I wouldn't be surprised by delays in that as well.

Of course, the company has its share of McClean Lake. Production there is expected to rise to 3.2 million pounds in 2008 from 1.8 million pounds in 2007. Denison's share rises to 720,000 pounds in 2008 from 405,000 pounds in 2007.

More good news -- 2008 marks the last year of the company's legacy contracts (at $20 to $26 per pound) end in 2008. Most of its other production is sold at 80% to 85% of spot, and there are other sales at 96% of spot. And Denison is making new contracts at potentially much higher prices, depending on the spot price of uranium going forward.

Its mills are the real gem, of course. It seems to me that Denison is not running those mills at full production. It remains to be seen if the production levels can be raised.

I don't mean to sound negative. Actually, many things about Denison are extremely positive longer-term. I expect we'll take our lumps for a month or two, then it should start rallying hard again. Because, as with Paladin, ERA and Cameco, if these companies are producing less uranium than expected, that puts upward pressure on the price of uranium, which puts more money in these companies' coffers even though their production is less than anticipated.

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