Description

Trading Idea: Short Centrus and long Silex Systems (ASX:SLX) and Cameco (NYSE:CCJ) to hedge commodity price and uranium enrichment hype risk while we wait for the US to ban Russian enriched uranium imports. 

Centrus is traded as a uranium stock and recently began to underperform most producers but still has much more downside. The stock should trade lower on news about banning Russian uranium imports but to offset the commodity price risk, pair this with a Cameco long (or another high quality producer) and Silex Systems long to offset the hype risk in enrichment. Uranium producers should trade higher on news about the US banning Russian enriched uranium imports because without Russian enrichment services, Western enrichers will need to overfeed their centrifuges to meet the enrichment shortfall in the West. Overfeeding requires more U3O8 and therefore increases demand for the product that producers such as Cameco, EU, and URG currently produce. The reason Centrus should trade lower on such news will be become clear below. 

Centrus has done very well as it’s benefitted from the 2023 uranium rally but they are at risk of losing 71% of LEU segment revenues and the market seems to misunderstand their business. The catalyst (US banning Russian enriched uranium) can come potentially any day, and is very likely to take place in 2024. The ban was originally expected to be passed into law in 1H24 according to presenters at the recent nuclear symposium at BoA. However, on April 16, 2024, the latest supplemental was released and the ban against Russia was not included. It’s still very likely that the ban passes in 2024 as most of the funding for domestic enrichment is contingent on the ban being enacted. The possible ways for the ban to get passed are as follows:

• Gets passed along with any “must pass” bill such as the reauthorization of the FAA  -  this can occur any time 

• Passed closer to the end of 2024 through the National Defense Authorization Act (NDAA)  -  most likely 

  • The first draft of the NDAA is expected to be released before Memorial Day (May 27, 2024). If the ban is included in this draft, there is a very high likelihood it gets passed into law through the NDAA closer to the end of this year

• An administrative ban can be implemented instead a legislative ban  -  this can occur at any moment and has a high likelihood of happening under the Biden administration

I will explain more about the $2.7 billion of US funding for domestic enrichment below but here is a screenshot of the provision of the appropriations that clearly shows the funding is contingent on a ban against Russia.

For some reason, Centrus’ stock traded up 5% on March 20, 2024 when Secretary Granholm announced that Congress is continuing to push for the US to ban Russian enriched uranium imports. This is the worst thing that can happen to Centrus. Centrus gets traded as part of the uranium stocks basket and is viewed as a “pure-play domestic enrichment.” With a clever ticker symbol of LEU (Low Enriched Uranium), it’s easy to assume they produce low enriched uranium without doing any further work into their story. Just as C3.ai snagged the ticker AI and isn’t really AI, Centrus doesn’t produce any LEU, they just resell it. And when they tried to produce LEU, they went bankrupt. Their pitch today is the same as it was when they were going into bankruptcy - the American Centrifuge Plant (the name of USEC’s LEU project). 

Main Findings:

• Potential downside of ~35-70%

• EBITDA flipping from positive $59m in 2023 to negative $30m by 2025

• Large disconnect between EPS of $5.39 and FCFPS of only $0.13

• Significant insider selling

• Higher than usual executive turnover

• Continued “bluesky” promise of producing LEU one day, with over 15 years of the same promise

Background & History:

Centrus is a nuclear fuels supplier to North American, European, and Asian utilities. Centrus supplies Low Enriched Uranium ("LEU") fuels to utilities (their ticker is LEU as well so i’ll use LEU to refer to Low Enriched Uranium, not the company), as well as providing technical consulting services to governments and private sector customers. 

Centrus was formerly known as USEC (United States Enrichment Corp) which was a state owned enterprise out of the Department of Energy (DOE) formed in 1993. USEC was fully privatized by the US government in 1998. USEC’s plans were to produce LEU and they were building a small demonstration centrifuge plant in Piketon, Ohio. This plant was supposed to begin commercial operations in 2009 but the DOE refused to loan them the $2 billion they needed. This caused the entire project to fall apart and in 2013 they filed for Chapter 11 bankruptcy. In 2014, they emerged from a successful restructuring as Centrus Energy Corp. Instead of trying to produce LEU now, they changed their business model to be a reseller of LEU. The key takeaways here are that LEU production is very costly (recall the $2 billion failed loan) and companies are reliant on lots of government funding and that Centrus tried to do it in the past which clearly didn’t work. As you will see later, every LEU enrichment company in operation today is a state-owned enterprise (SOE).

Centrus’ main business now is acting as a broker/reseller of Russian LEU (Low Enriched Uranium) through their agreement with TENEX (an overseas trading company owned by Russian state-owned company Rosatom). LEU is fuel enriched to 3-5% U-235 (the fissile uranium isotope) and is used for essentially all operating nuclear reactors today (except for Candu reactors in Canada). There are ~411 global operating reactors today, 61 under construction, and another 108 planned. All of these reactors will require LEU fuel. 

HALEU (High Assay Low Enriched Uranium) is another form of reactor fuel which uses LEU as its feedstock and further enriches the fuel to levels between 5-20% U-235. HALEU is the fuel required for most SMR's (small modular reactors) and advanced reactors. There are currently no SMRs operating and based on NuScale's sole project being canceled and X-Energy's SPAC transaction being canceled, it looks like there won't be any SMRs operating for at least the next 5-10 years, at a minimum. In the US, the NRC (Nuclear Regulatory Commission) makes it very timely and costly to obtain the necessary licenses and permits to build and operate an SMR. 

Centrus operates two business segments:

1. Broker of Russian LEU (84% of 2023 revenue). Centrus imports LEU from TENEX (Russia) and resells it to Western utilities. This supply contract expires in 2028

   1. Technically, they import LEU from TENEX and Orano but are primarily sourcing from TENEX. Based on conversations with management and consultants, I estimate at least 87% of their LEU supply comes from TENEX. The assumption stems from the following:

      1. Inventory 2022 = $209 million

      2. Inventory 2023 = $306 million

      3. Therefore, the cash flow statement should show a decrease of cash in the amount of $97 million

      4. The cash flow statement only shows a decrease in cash due to changes in inventory of $84 million

      5. The $13 million delta is due to non-cash inventory (inventory on their books but not purchased in current year)

      6. TENEX inventory is “just in time” inventory meaning it’s cash inventory

      7. Therefore, TENEX accounted for $84/$97 million of inventory in 2023 = 87%

   2. Their 10-K states “TENEX Supply Contract is the major source of supply that the Company relies upon today to meet its delivery obligations and to earn the revenues needed to fund our operations, including our advanced technology work”

2. Centrus Technology Segment (CTS) (16% of 2023 revenue) provides consulting service to public and private sector customers as well as produces HALEU. They have a three-phase project ongoing with the Department of Energy (DOE) to produce HALEU.

   1. The US government is supporting their CTS business by providing funding for Centrus to produce small amounts of HALEU to allow the government test advanced reactor designs. They are working on a three phased “HALEU Operation Contract” with the DOE. The total contract value is $150 million.

      1. Phase 1: was completed in November 2023

         1. Centrus received a $30 million cost share contribution from the DOE. Essentially, Centrus spent their own $30 million and received $21 million ($30 million - $9 million SG&A) in funding from the DOE for a total value of $60 million/$150 million. They had to produce 20kg of HALEU which is a small amount

      2. Phase 2: Centrus is expected to receive $90 million in between 2024-2025 in return for producing HALEU at an annual rate of 900kg (not actually 900kg/yr). They will be compensated on a cost-plus-incentive-fee basis 

         1. The $90m remaining contract value will be recognized as costs are incurred and will be recognized in cost of sales

         2. Essentially, this comes out to 9% gross margins

         3. Example: Centrus spends $90 million over 12 months = $7 million/month. Each month they would recognize $7.7 million in revenue (additional $700k is the 10% incentive fee)

         4. Gross margins are expected to be closer to 20% in the near term and will decrease over time as their SG&A costs will be reimbursed (and show up in revenue) but the actual costs will be below the gross profit line

      3. Phase 3: The DOE can contract HALEU for up to 9 years in 3 year increments

         1. Gross margins will also be ~8-9% as they will recognize $1.09 in revenue for each $1 of costs incurred 

The problem is that there is no market for HALEU. There is not a single SMR operating today and therefore not a single reactor that requires HALEU fuel. SMR’s are expected to come online in the 2035 timeframe, if at all. The only opportunity in the uranium enrichment market is the LEU market, not the HALEU market. Centrus tries to convince investors that they can operate in the LEU market but I believe they can’t as explained below. Their 10-K reads “Centrus is pioneering US production of HALEU, enabling the deployment of a new generation of HALEU-fueled reactors” (in other words, SMRs. Despite clearly stating they’re only working on the production of HALEU, Centrus continues to try to sell the idea that one day they may be able to produce LEU.

Front End of the Nuclear Fuel Cycle:

Understanding the front end of the nuclear fuel cycle is crucial in understanding why Centrus' future prospects are at major risk. 

• Step 1 (mining and milling): mine uranium from the ground and process it to get a product called U3O8 (aka yellowcake). This has a natural concentration of 0.711% U-235 (the fissile isotope)

• Step 2 (conversion): convert U3O8 powder into a gaseous form called UF6

• Step 3 (enrichment): enrich this gaseous UF6 to levels between 3-5% U-235 for all of the operating reactors today (except Candu reactors), to levels of 5-20% for SMRs (zero operating today and likely none for next few years at a minimum), or to levels above 20% for nuclear weapons

• Step 4 (fabrication): LEU (3-5% U-235 concentration) is converted into uranium oxide and formed into ceramic pellets and made into fuel assemblies

• Step 5 (nuclear power plant): the fuel assemblies are loaded into reactors to create energy from a chain reaction

Step 3 (Enrichment) is where Centrus operates but is also where they face all of their risk. 

The Enrichment Market:

There are only four major operators that can enrich uranium in the LEU market.

• Rosatam (Russian company run by TENEX) has capacity for 27.7 million SWU  — East

• Urenco (Germany-Netherlands-UK SOE) has 18.6 million SWU capacity  — West

• Orano (French SOE) has capacity for 7.5 million SWU  — West

• CNNC (Chinese company with no export laws) has capacity for 6.3 million SWU  — East

The enrichment market is measured in SWU (Separative Work Units) which can be thought of as the effort required to enrich uranium. Russia dominates the enrichment market with 46% market share (27.7M SWU / 60.1M SWU total). Russia is a low-cost producer of enriched uranium because during the Cold War, the Soviet Union invested heavily in nuclear weapons and built a lot of enrichment infrastructure giving them economies of scale and a head start. 

A rule of thumb in the industry is that it costs ~$1 billion to build a capacity of 1 million SWU. For example, in 2012 when USEC (now Centrus) was working on their “American Centrifuge Plant” in Piketon, Ohio, before going bankrupt it was estimated to cost $3.5 billion and was designed to have an annual capacity of 3.8 million SWU. Today, each operable enrichment plant is owned by governments due to its capex intensive nature. Centrus would be the only non-state owned facility if they were to produce LEU, which management would love for you to think is possible. It’s interesting to note they’ve essentially spent ~$1m/yr on capex since 2018…If they wanted to enter the LEU market and be competitive with Orano in the West (smallest player & also their only supplier outside of TENEX), they would need to source $8-10 billion dollars. It would also take 3-5 years of construction to get to first production which would have an insignificant capacity output until further cascades are built.. 

More recently, in July 2023, Urenco announced that they will be expanding their capacity at their US site as they’ve received new commitments from US customers for non-Russian fuel. Their new centrifuge cascade will be online in 2025. This demonstrates Urenco’s dominance as the LEU leader in the West. They can increase capacity to meet customer demand very quickly. There’s no way Centrus can compete with them. 

We can see Centrus spends significantly less on capex than those operating in the LEU market. Management claims that the income statement line “advanced technology costs” is a form of capex. Seems weird to me that it’s not considered capex on the financial statements if it truly was capex. Regardless, we can see Centrus really underspends peers in this space. The reason is because Centrus does not produce LEU.

Bifurcated market - West vs East:

Ever since Russia invaded Ukraine in February 2022, Western countries (USA, Canada, Australia, Europe, etc) have been trying to de-risk their fuel supply away from Russia. This has caused a bifurcated market (West vs East). The US government has provided a few billion dollars of funding to begin the process of removing our dependance on Russia. Examples include:

• March 2024: $2.7 billion for US domestic enrichment services.

  • Note: this applies to LEU and HALEU enrichment with majority for LEU production. Therefore, most of the funding will be given to Urenco USA and Orano USA 

  • Risk to Centrus: these funds are contingent on a ban of Russian material being enacted. Therefore, until H.R. 1042 goes into law OR the Biden administration imposes an administration ban, this funding cannot be used. Since the bill is backed by the Nuclear Energy Institute and the largest utilities in the US, it’s very likely to get passed through legislation in 2024

• HALEU availability program which will provide $700 million and is allocated from the IRA

  • Note: funding is only through September 2026 and spans multiple parts of the fuel cycle such as enrichment, deconversion, transportation, and more. Therefore, Centrus will receive a portion of this funding for HALEU enrichment, BWXT will likely receive some for deconversion, and the rest will go to other companies

  • The US provides much less funding for HALEU since there’s currently no market for it

The most important catalyst of all is H.R. 1042 “Prohibiting Russian Uranium Imports Act.” US Congress has been progressing this bipartisan bill for a year now and in December 2023, was passed through the House. In early 2024, the bill went through the Senate and was blocked by Senator Ted Cruz because he wanted to get a semiconductor plant approved in his state. It’s important to note he was the only senator to block it. The US government is smart enough to realize that we don’t have enough enrichment capacity in the West to substitute our Russian supply for our nuclear reactors which is why this bill can provide waivers to companies still in need of Russian LEU. These waivers will expire in 2028. 

On March 20, 2024, Secretary Granholm announced the importance of this bill and the ongoing effort to ban Russian imports. Since Senator Cruz was the only senator to vote against the bipartisan bill, the expectation is that this bill gets passed through the Senate in the near term. At first glance, all of this government funding may sound positive for Centrus as the US needs domestic LEU enrichment but it really isn't since Centrus doesn’t produce LEU. Russia has hinted multiple times that if the US goes through with this ban, Russia will immediately cut off exports to the US. Centrus argues that Russia could have done this anytime in the last couple of years but in reality, the US only really began making a hard push for this recently (as evidenced by the $2.7 billion domestic enrichment funding passed in March 2024). 

Urenco and Orano’s customers are primarily utilities whereas Centrus’ main customer is the DOE. Utilities prefer not to have a monopoly market and currently in the West have a duopoly. Global Laser Enrichment (GLE) is expected to come online in 2029 which would make it an oligopoly in the West, even better for utilities. The US government through the DOE buys HALEU for the purposes of storing it in case SMR’s come online next decade whereas utilities buy and contract LEU to keep their reactors online today and in the coming years. Therefore, I expect Urenco, Orano, and GLE to receive US government funding for their US subsidiaries to continue producing and increasing LEU production whereas Centrus will receive smaller sums of government funding to produce HALEU for the government to stockpile. 

Market size:

• LEU: the global uranium enrichment market requires ~55 million SWU per annum. At a price of ~$150/SWU, that makes the LEU market worth ~$8.3 billion per year.

• HALEU: $0

Bull Case on Centrus:

• Only pure-play US enrichment company

  • Counter: Global Laser Enrichment (GLE) (through Silex Systems and Cameco) is a better US pure play as they have lower capex and more versatile tech

• Only US company with a license from the NRC to produce HALEU 

  • Counter: that’s correct because other competitors focus on licenses for LEU production since HALEU market is non-existen

• Can enter the LEU market which is a large opportunity

  • Counter: can’t compete with Urenco and GLE is planning to enter this market in 2029, which would be when Centrus could begin LEU production if they began construction today

  • Also, every enricher that produces LEU is state-owned since it’s so capex intensive. GLE requires 50% less capex than a typical centrifuge cascade which is how they will be able to compete. Centrus doesn’t have that luxury

• Centrus can easily reconfigure their HALEU centrifuges into LEU centrifuges so they can pivot to LEU production with low capex

  • Counter: It’s true that from a technical standpoint they just need to reconfigure the pipes to convert a HALEU centrifuge into a LEU centrifuge

  • The problem is that the DOE bankrolls them currently to produce HALEU. To be somwhat competitive in the LEU market, Centrus would need to use their entire facility to produce LEU. This is because each centrifuge cascade only has 35,000 SWU capacity and their existing facility only has room for 11,000 centrifuges (further calcaulations below - search “25,800”). There is no chance the DOE will let them stop producing HALEU. Therefore, Centrus would need to use their existing facility to either:

    • produce less LEU (being less competitive) to continue producing HALEU for the DOE or

    • Get a new facility to produce LEU in one place and HALEU in another

  • Conclusion: it’s true that reconfiguring centrigues is easy but they won’t be able to focus only on LEU, therefore they would need two sets of centrifuges which is very costly

• Will receive lots of government funding from these new grants being created from the US government

  • Counter: Urenco USA and Orano USA will receive majority of funding. Centrus and GLE will receive smaller amounts

  • Majoirty of the US government funding is contingent on banning Russian imports

  • Therefore, for Centrus to receive some government funding over multiple years, they need to lose their primary revenue stream immediately 

Market participants keep preaching the bull case that there’s a chance Centrus will produce LEU one day. This stems from management misleading investors. A few examples of misleading information from CEO, Amir Vexler, on their Q4 2023 earnings call.

• “The potential for large-scale production of LEU for existing reactors as well as HALEU for advanced reactors is right there and waiting”

  • There is large-scale potential for production of LEU, especially as the market becomes increasingly bifurcated, but there isn’t large-scale production for HALEU as there are zero advanced reactors operating. Therefore, you will be waiting a long time for demand for HALEU to pick up

  • Conclusion: Amir Vexler, CEO is literally telling you that there is only demand for LEU which Centrus does not produce

• “Although the U.S. House of Representatives passed legislation late last year to prohibit the importation of Russian nuclear fuel, there is a growing understanding in the industry and among policymakers that transitioning away from dependence on Russia will take years and requires investment in new domestic capacity.”

  • He’s talking about H.R. 1042 “Prohibiting Russian Uranium Imports Act” that passed the House in December 2023

  • There is a growing understanding that transitioning away from Russia will take years which is why the bill has included waivers to companies needing to import Russian LEU until 2028. Russia doesn’t export HALEU since there’s no end market for the product

  • The US operates the most nuclear reactors in the world. Policymakers recognize the transition requires investment in new LEU domestic capacity to keep our reactors online. None of these reactors require HALEU and policymakers recognize that

  • Conclusion: Amir’s statement is correct but has nothing to do with Centrus as they don’t produce LEU

• “We are well positioned to compete for the DOE’s RFP work as we are the only U.S. owned U.S. technology enricher in the marketplace, especially since we could offer the fastest pathway to large-scale HALEU production”

  • Global Laser Enrichment (through Silex Systems and Cameco) is another US owned enricher that can will have the ability to produce both LEU and HALEU

  • Yes, Centrus is currently the fastest to market when it comes to producing HALEU but that’s because no one cares to produce HALEU at the moment since  there is no market for it

  • Every competitor is focused on producing LEU, even GLE is targeting LEU because there only exists a market for LEU

  • Conclusion: Amir is right that they are best positioned to produce HALEU but this is because they have no competitors as everyone is focused on the LEU market

Another example illustrating there is no market for HALEU: Centrus and X-Energy (a SMR company that tried to go public via SPAC in 2023 and ended up canceling the transaction due to low investor demand) had a contract to build out X-Energy’s TRISO fuel fabrication facility which technically still exists although there hasn’t been any activity on it in the last couple years. Centrus seems to have quietly swept this under the rug and has avoided providing any updates on this contract as it shows there is no commercial market for HALEU yet.

The only thing to remember about the bull case is that Centrus (back when they were USEC) were promising the same thing as they are today, that one day they may produce LEU. It’s now been over 15 years of the same promise. When they truly attempted to produce LEU, they ended up going bankrupt. Today, they aren’t even spending on capex and the amount of funding they will need if they wanted to be slightly competitive would be a minimum $8 billion (based on the rule of thumb that it costs ~$1 billion to build 1 million SWU capacity and they would need to have similar capacity to Orano)…so investors bidding up the stock on this bull thesis will be waiting indefinitely.

Don’t just take my word for it, below are comments from Clay Montgomery, a nuclear advocate and investor. 

This comment illustrates the misleading management and high capex requirements.

Insider Selling & Executive Turnover:

There has been significant senior level turnover with the CEO leaving in January, 2024 following the CFO’s and CCO’s departures in June and August, 2023. 2023 also saw the departure of two directors.

Executive turnover in the last year:

• Daniel Poneman, Former CEO (from 2015-2024)

• Philip Strawbridge, Former CFO (from 2019-2023)

• Dennis Scott, Former GC and CCO (from 2015-2023)

• Thomas Jagodinski, Former Director (from 2014-2023)

• Neil Subin, Former Director (from 2017-2023)

Centrus’ board members associated with poor performing companies:

• Kirkland Donald, Director - serves on the advisory board at NuScale (NASDAQ: SMR) which has had a troubled history. They were supposed to be the first commercial operating SMR in North America but their only customer contract fell through. Iceberg research published a short report on NuScale in October, 2023. 

• Mikel Williams, Director - serves on board of B. Riley (NASDAQ: RILY) which has also been the subject of bearish reports by Wolfpack Research and The BearCave claiming they’re over leveraged to speculative assets

• Neil Subin (Director at Centrus until December, 2023) - serves on board of NextNav (NASDAQ: NN) which was written up by Bleecker Street Research who claimed they’ve had no traction building a better alternative to GPS and instead aligned themselves with selling real estate in the Metaverse, self-driving cars, and flying cars 

• Tina Jonas, Director - serves on the Board of Virgin Galactic (NYSE: SPCE) which has been a complete failure in the aerospace sector with the stock down 89% since going public via SPAC

Insider Selling:

The people who would know the business the best were likely to be Dan Poneman, CEO; Philip Strawbridge, CFO; Morris Bawabeh, largest shareholder. Each one of them sold stock in 2023. What’s interesting is that Morris Bawabeh became a seller in 2023 after buying stock since Centrus came out of bankruptcy last decade. Dan Poneman also has an impressive political background and a great grip of the risks Centrus faces due to the US’s political push to ban Russian imports.

• Dan Poneman, Former CEO was not shy about selling stock including during his tenure. He has an impressive background as former Deputy Secretary of Energy and COO of the DOE. He likely has very clear insights into the political landscape and especially the bill H.R. 1042 - Prohibiting Russian Uranium Imports Act. Since the beginning of 2022, Dan has been a continuous seller of stock. Each time he receives stock from vested RSU’s, he sells them immediately. More recently, in February 2024, Dan sold his largest block worth $11.8 million dollars…Given Dan’s connections to the DOE, this large sale likely shows his fears about Russian stopping exports to the US of enriched uranium

• Morris Bawabeh, major shareholder of both stock and bonds. He accumulated his way to becoming a 20% shareholder beginning in the years after their bankruptcy and turned into a seller in late 2023 when the stock surpassed $50/share

• Philip Strawbridge, Former CFO completely sold all of his holdings between October 4, 2022 - October 12, 2022 for total gains for ~$2 million. Note this is the same time that Morris Bawabeh made large sales.

The Downside Risks:

As a reminder, 84% of Centrus’ ~$320 million TTM revenue is generated by reselling LEU and 87% of that is estimated to be sourced from Russia. Therefore, as the H.R. 1042 bill progresses through Congress, Centrus faces an increased risk in losing a very significant chunk of revenue. If Russia retaliates and completely bans exports to the US, I estimate $141 million of LEU revenue to disappear in 2024. This worst case scenario is likely to happen and can take place at any time. Another scenario that’s also likely is that Centrus continues to receive imports of LEU from Russia through the waivers issued by H.R. 1042, once it gets passed into law. The problem with this scenario is their contract with TENEX expires in 2028. With the very strong movement from Congress to ban Russian imports from Russia it’s highly unlikely that Centrus will be allowed to renew their contract with the Russians. This means that Centrus needs to find a new supply of LEU. They currently have an insignificant amount of supply from Orano. Centrus hired their new CEO Amir Vexler in January 2024 who came over from Orano. Clearly Centrus is nervous about losing their Russian LEU supply. The problem about relying on Orano to fill their soon-to-be-lost supply from Russia is two-fold:

1. Centrus’ contract with TENEX had one price reset and Centrus fixed the price of their LEU supply in 2019 when SWU prices were at all time lows of ~$40/SWU. This was a great call by Centrus. SWU prices today are $160/SWU. Therefore, gross margins should have expanded from 2018 to today, although the contract has a market related mechanisms built in

   1. Their 10-K states “a market related price reset provision in the TENEX supply contract took effect in 2019 - when market prices for SWU were near historic lows - which has significantly lowered our cost of sales and contributed to improved margins since 2019”

   2. The problem now is that Centrus needs to begin contracting for LEU supply today to fill their needs for 2027/2028 and onwards since the enrichment market operates through long term contracts. With SWU prices at $160/SWU, their gross margins will likely compress in the near future as they can no longer benefit from that one time “price reset.”

2. They are relying on Orano to fill their supply needs but Orano doesn’t have as much SWU capacity as TENEX (7.5m SWU vs 27.7m SWU) and Orano has existing contracts with other customers as well, meaning Centrus can’t just come in and take all of their production away from Orano’s existing sales contracts. This means Centrus might not be able to find enough supply to replace their imports from Russia and would have to lower their transaction volumes, decreasing revenue.

You might be wondering, why doesn’t Centrus wean off of Russia by turning to Urenco (the largest Western enricher - recall Orano and Urenco are the only Western operators) for LEU supply? The reason is that Urenco is the market leader in the West in the LEU market, owning 71% of the Western market and Centrus would be helping their largest competitor by purchasing through them. Centrus claims their “big opportunity is producing LEU” but it’s unlikely they could compete in the LEU market (if they ever were to operate there). 

1. First, I assume they aren’t contracting from Urenco as that is their largest competitor if they were to enter the LEU market

2. Second, Urenco can produce LEU more efficiently than Centrus and is already established in the market. They announced in July 2023 they’re increasing capacity by 15% since they won contracts from US customers for increased demand 

3. Third, it would take 3.5 years for Centrus to build their first centrifuge cascade, meaning they wouldn’t start producing until ~2028 at the earliest if they started construction today (which they haven’t).

Additional challenges they face include:

1. First production would also be insignificant as each cascade has 35,000 SWU capacity. Orano is the smallest Western enricher with 7.5 million SWU capacity. Therefore, Centrus would need 215 cascades to match Orano’s capacity to be somewhat competitive in the LEU market. Each cascade includes 120 centrifuges, therefore Centrus would need to build 25,800 centrifuges to match Orano’s capacity. Unfortunately, they only have capacity for 11,000 centrifuges at their Piketon, Ohio, facility. Not to mention the years of construction it would take to get to scale. 3.5 years is just for the first cascade of 35,000 SWU capacity, 6 months for the second cascade, and 2 months for each following cascade

2. Total capex required for this buildout would be ~$3 billion dollars. With capacity for 11,000 centrifuges (assumes they completely stop HALEU production and use the entire facility for LEU production) and 120 centrifuges per cascade, that means they have space for 95 cascades (11,000 / 120). 95 cascades at 35,000 SWU per cascade = 3.2 million SWU capacity. With ~$1 billion in capex per 1 million SWU capacity, that comes to ~$3 billion total capex. They currently have ~$200m in cash.

3. Lastly, there is a more efficient technology that requires 50% less capex than the traditional centrifuge technology which is laser enrichment. Silex Systems and Cameco have a JV called Global Laser Enrichment (GLE) which is based in the US. Many people believe Centrus is the only pure-play US enrichment company but GLE is another player in the space, also located in the US, and better situated to benefit from this bifurcation movement. Besides having lower capex than Centrus, GLE also has ~60% of the DOE’s UF6 stockpile contracted for already which is the feedstock required to produce LEU, whereas Centrus does not. Laser enrichment is unproven at commercial scale but GLE has their TRL-6 readiness demonstration in 2024. This is a massive catalyst for them which would take their tech from a science project to a commercially viable tech. 

Historical Financials Overview:

Historically, their business has not demonstrated strong revenue growth and has also experienced a large disconnect between earnings and free cash flow. 

A few adjustments to revenue:

• In 2020: Adjusted SWU revenue to exclude a one time payment of $32.6 million from a legal settlement from one of their customers going bankrupt.

• In 2021: Adjusted CTS segment revenue to exclude $43.5 million related to the settlement of their claims for reimbursements for pension benefits costs incurred in 3Q21

Revenues really only grew in 2022 which was driven by a combination of both an increase in SWU prices due to Russia invading Ukraine and an increased volume of SWU sold. Centrus’ LEU gross margins have increased since 2019, aligned with their TENEX price reset. This margin expansion will revert as they look to find a new source of supply.

Their CTS segment relates to producing HALEU for the DOE. It’s interesting to note that despite receiving favorable funding from the government, it still hasn’t been a profitable business for them.

They experienced impressive revenue growth in “uranium” during 2023 but since most of the buying/selling is done in the spot market, the margins are very thin in that business. Despite the YoY revenue growth in 2023, they actually saw gross margins compress.

They’ve also had increasing accounts receivables in 2022 and 2023. While revenues have been growing, they’ve been growing at decreasing rates while receivables have grown more quickly since Russia invaded Ukraine.

A potential red flag is receivables and inventory growth outpacing revenue growth in both 2022 and 2023. While there’s no real obsolescence risk to inventory, most of the build has taken place beginning in 2022 when SWU prices were between $80-$130/SWU. The increase in SWU prices was caused by the market pricing in the lost access to Russian enrichment services. If we do not lose access to Russian SWU then prices should revert, putting Centrus at risk of possible impairments.

Their days of inventory on hand (DOH) has ballooned from 181 days in 2021, to 433 in 2022, and 537 in 2023. Centrus has been building inventories ever since the Ukraine war began in preparation for losing their Russian supply. This should provide them with a buffer if Russia halts exports to the US, although management has stated that higher inventory levels is the new norm. While this may keep Centrus operational for a few quarters, they will run into a wall where they will either be (i) unable to replace the supply from TENEX from a willing seller and/or (ii) subject to replenishing their inventories at much higher SWU prices all but wiping out profitability. 

The combined increase in accounts receivables plus a building of inventory can lead to cash flow problems in the future. Especially in a time where they need to spend money building their HALEU centrifuge cascades in order to capture the DOE funding from phase 2 of their project. In times where worst-case scenarios can occur at any moment, a cash crunch is the last problem you need.

Valuation Scenarios:

Historically, Centrus has traded at TTM normalized multiples of:

• EV/Sales multiples of 1-3x 

• EV/EBITDA multiples of 6-9x 

• P/S multiples of 1-3x

In 2021, the stock ran up into their Q3 2021 earnings in November, 2021 reaching a price of $85/share. This was primarily caused by hype surrounding SMR’s. During their earnings call, management disclosed large contracts with the DOE and talked about how much HALEU demand they are expecting in the coming years. Almost three years later and there still isn’t a single operating SMR.

Price targets and valuation scenarios:

Worst case (45% probability): Russia stops exporting enriched uranium to the West

• Fair price of $13.29, representing 70% downside from April 10, 2024’s share price

• SWU revenues would drop from $209 million in 2023 to $27 million in 2025

• Assumptions listed below but I apply generous growth to their CTS segment

Base case (50% probability): slowly wean off Russia by procuring higher cost SWU from Orano

• Fair price of $28.94, representing 35% downside from April 10, 2024’s share price

• Gross margins should compress as they will no longer benefit from their one-time price reset with TENEX

• I assume they can procure enough SWU from Orano to replace all of their TENEX supply, which I believe is too bullish

Best case (5% probability): US doesn’t ban Russian imports and SMR’s need HALEU to test operations

• Fair price of $54.63, representing 23% upside from April 10, 2024’s share price

• US congress decides not to ban Russian imports and Russia doesn’t retaliate while the DOE pays Centrus for Phase 2 and 3 of the HALEU contract 

• Centrus will need to raise lots of money for construction which will require 62% share dilution to current shareholders

Worst case assumptions:

Catalyst

• H.R. 1042 bill passes the Senate and then gets passed into Law OR there is an administrative ban put in place

• Russia retaliates to the US banning their uranium imports and cuts off the US instead. The waivers from H.R. 1042 would be useless in this case

• Gross margins begin compression due to obtaining supply at higher SWU prices

• Uranium spot price declines following 2023’s 82% gain to levels 30% the LT marginal cost of supply