First Uranium – Raising equity financing

First Uranium (TSX: FIU) announced they closed a $52 million equity financing at $1/share. They had originally had $46 million subscribed with a $6M greenshoe embedded.

This is about a 22% dilution of equity interests in the company, but they need this money to bridge their future operations and implement their capital plan:

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FIU CONSOLIDATED                 end       end       end       end       end
(000's)                      Mar '11  June '11  Sept '11   Dec '11   Mar '12
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MWS: Cash generated from                                                    
 operations                   12,032    16,295     7,444     8,619    13,873
MWS capital expenditures    (17,816)  (12,649)   (7,093)     (337)     (143)
Ezulwini: Cash (utilized                                                    
 in) generated from                                                         
 operations(1)               (9,449)   (3,823)     (411)     4,964    10,098
Ezulwini capital                                                            
 expenditures                (5,236)   (6,580)   (6,677)   (5,938)   (4,927)
FIU corporate expenditures   (2,875)   (2,726)   (3,726)   (2,726)   (2,726)
Interest on convertible                                                     
 debentures                  (7,301)   (3,156)   (7,301)   (3,156)   (7,147)
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Cash movement for the                                                       
 quarter                    (30,646)  (12,639)  (17,765)     1,427     9,027
Minimum proceeds from                                                       
 financing raise(2)           46,000                                        
Less: estimated financing                                                   
 transaction costs           (2,675)                                        
Opening balance               29,979    42,658    30,019    12,254    13,681
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Closing Balance               42,658    30,019    12,254    13,681    22,708
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COMMODITY AND EXCHANGE RATE                                                 
 ASSUMPTIONS                                                                
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Gold price US$/oz               1380      1390      1390      1390      1390
Uranium price US$/lb              65        65        65        65        65
Gold price ZAR/kg            301,703   303,889   303,889   303,889   303,889
ZAR/US$ exchange rate           6.80      6.80      6.80      6.80      6.80
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What this means is that if the company did not raise money by the end of the month, they would be out of cash – but they need about $42M in capital expenditures in order to buy themselves enough time to build the Ezulwini mine to the point where it can start generating free cash flow.

Assuming they have the operational side covered (which is never a given considering the sketchy history of the company), their next looming financial issue is how to pay off the subordinated convertible debentures, of which $150M is outstanding and due to mature on June 30, 2012. It is low cost debt (4.25% coupon), but if the company is generating free cash flow at this time, it is likely they will be able to rollover the debt at a higher coupon and extend the term out another five years. This will not happen until the first half of 2012.

If the company gets to this point of being free cash flow positive, the equity will be worth well more than a dollar a share. But this is a very risky play – if it works, investors will likely get a very handsome return on investment over a two year period. If it blows up, the common shares will go to zero.

The other embedded risk is commodity pricing – both currency and gold pricing.

The subordinated debt has traded at around 82-83 cents today, which is the highest it has been since early 2008. Disclosure: I do have a position in First Uranium’s notes.

The easy trade is the dangerous trade

The easy trade these days appears to be in crude oil, and to a lesser degree, commodities.

My trading gut instinct says that the crude market may be a tad overextended at the moment, presumably due to geopolitical instability.

Modern historians should note that Iran and Iraq went through a decade-long war, yet the Persian Gulf still managed to export billions of dollars of crude.

The big shoe to drop is the answer to the question of “What happens in Saudi Arabia?” since they control a significant source of supply globally. That said, it is highly likely that the oil will still flow since whoever is left to control government will still want the cash cow – what will be significantly more disruptive is that the incumbent administration knows it will be kicked out, but has plenty of notice of its pending demise. In this scenario, they will likely use the “scorched earth” option, similar to what Saddam Hussein did in Kuwait prior to the first Iraq invasion.

Readers will likely note that their holdings in Canadian oil sands related companies have received a significant amount of appreciation over the past 6 months – partly related due to the market conditions and improving economy. Here is a chart of Cenovus (TSX: CVE), but you can pretty much fill this in with the usual suspects (Suncor, Canadian Natural, etc.):

The last spike up over the past month is a function of higher crude prices and geopolitical instability – I’d estimate of the $6 that it has gone up from $32 to $38, half of that is due to crude, and half of it is implied instability.

That said, it seems like an easy trade to pile in at the moment, so be very cautious – when others think alike, your risk/reward ratio becomes more adverse.

Large caps appear cheaper than small caps

Just from my cursory examinations of the markets, it appears that large cap stocks are representing a better value than smaller capitalization issues. I am guessing the market is discounting some form of zero-growth projection in the future for a lot of these firms. One factor to remove from the analysis is government revenues – the theory would be that companies with higher exposure to government business will face pressure as deficits will force spending cutbacks.

Because of the currency differential, US stocks appear to be a better value at the moment – dividend-bearing companies can also be put in the RRSP to avoid withholding tax.

Just as the most basic example, Walmart (NYSE: WMT) is projected to earn about 8.5% of its capitalization this year – much better than sticking it in a 10-year government bond yielding 3.41%. You would think that the company would be able to scale its business appropriately if there was a recession – indeed, by looking at the stock chart you would be hard-pressed to see even a hint of an economic crisis in 2008-2009. You don’t even have to do any research – there is virtually no chance of Walmart not being able to produce profitable retail business in the medium-term future. This is contrasted with Amazon, which has to justify its valuation with huge amounts of growth over the next decade.

You will never see your investment in WMT rise by 30% in a year, but then again, you will not see it sink 30% either. It almost trades like a bond. It is a typical good “grandmother” stock.

There are many better (and smaller) examples of large cap companies that are trading at very attractive valuations, have a “moat”, and unlike Walmart, you could envision scenarios where they will warrant higher valuations.

Onset of food price inflation

The best measure for food price inflation is usually through Loblaws’ quarterly releases.

In their year-end release, they have the following comment on food prices:

– the Company’s average quarterly internal retail food price index
was flat. This compared to average quarterly internal retail food
price deflation in the fourth quarter of 2009.

Anecdotal evidence by my food shopping trips to Superstore would suggest that food prices are increasing somewhat. For example, a 4 litre jug of milk is about CAD$4.40 presently, while a couple years ago it used to be around $3.90. The BC Dairy Board might have to do with this price increase. I also notice prices for bread products creeping up to around CAD$3 for a 1.5 pound loaf of good quality bread, although they do have a freshly baked 99 cent French Bread which is a very good value if you can use a knife to slice it. It has been this price for the past five years.

Staple commodities such as grains and sugar have been rising significantly over the past couple years since the economic crisis, and combining this with energy price increases, there doesn’t seem to be a way that costs can be kept down other than with removing labour costs from products. This does not bode well for employment.

Bank of Canada Interest Rate Projection

I am projecting that the Bank of Canada will leave the short term interest rate target at 1%. Their next policy rate announcement is on Tuesday.

BAX Futures for March are at 98.67, which suggest a low probability of a rate hike, but I stated before that I very much doubt the Bank of Canada will move until the 10-year benchmark yield is over 3.5% – with the geopolitical instability in North Africa, rates ended last Friday at 3.29%.

Especially with the Canadian currency at relative highs against the US dollar (which has a dampening effect on the export-driven Canadian economy) a rate hike seems unlikely at the moment, but the wording of the text may suggest that the next meeting may consider a hike if conditions warrant, beyond the already existing language.