DBRS Confirms Cameco at A (low), Changes Trend to Negative

DBRS Limited (DBRS) has today confirmed the Issuer and Senior Debt ratings of Cameco Corporation (Cameco or the Company) at A (low) and its Commercial Paper rating at R-1 (low), but has changed the trends to Negative from Stable. Furthermore, unless there is a significant improvement in the Company’s outlook a downgrade in its ratings is likely.

Although Cameco remains one of the world’s largest and most cost-competitive uranium producers with a range of risk-aversion features in its sales contracts, uranium markets have been persistently weak since the serious nuclear accident at the Fukushima Daiichi power plant in Japan in 2011. High capital expenditures (capex), now being reduced, dividend payments and net acquisitions have materially increased Cameco’s net indebtedness in the last five years. Dispositions have narrowed its business profile and it continues to face ramp-up risks at its new Cigar Lake operation. Most of the Company’s key credit metrics have weakened over the last several years to levels weak for its current ratings (except debt-to-capitalization, which remains solid) with little prospect for material improvement in the near term.

To compound these issues, Cameco has been subject to reassessments of its historic tax filings that may require a material outflow of funds, significantly depleting its financial resources. The Company has received income tax reassessments by Canada Revenue Agency (CRA) related to intercompany uranium sales and transfer pricing issues for the Company’s 2003 to 2009 tax years and it expects further reassessments for its 2010 to 2014 tax years. The CRA audits could result in total cash taxes and transfer pricing penalties of $1.5 billion for the 2003 to 2014 tax years. DBRS estimates related interest on unpaid amounts could raise the obligations to the $2.0 billion level, of which a portion has been paid to date. At the time of the reassessments, Cameco is required to pay 50% of the total cash tax amount and transfer pricing penalty amounts and any related interest charged. To date, payments related to reassessments received have totalled $248 million related to the $820 million of added tax expense for the 2003 to 2009 tax years. Cameco disagrees with the reassessments to date and has stated its intention to contest them as well any further similar reassessments in court. Nonetheless, the Company will have to make payments of 50% of additional cash taxes and any related interest and penalties payable pursuant to the reassessments that may be received for the 2010 to 2014 tax years. The Company indicates it is exploring the possibility of providing security in the form of letters of credit as an alternative to paying cash. If the Company is fully successful in contesting the reassessments in court, then all monies paid will be refunded. If not, in addition to any payments already remitted, Cameco will have to pay any outstanding cash taxes, transfer pricing penalties and interest owing.

In addition, the 2009 tax filing of the Company’s U.S. subsidiaries has been audited by the United States Internal Revenue Service (IRS) challenging the transfer pricing used under certain intercompany transactions including uranium purchase and sales arrangements in 2009 as well as the compensation being earned by Cameco Inc., one of those U.S. subsidiaries. Proposed adjustments arising from the 2009 audit seeks an additional USD 32 million in tax plus USD 7 million in penalties (plus interest on any amounts found to be owing). The Company is also contesting these proposed adjustments, no cash payment is required prior to final judgment. IRS adjustments to tax years subsequent to 2009 are also expected.

Resolution of tax cases is not expected in 2015. Unsuccessful appeal on the CRA and IRS tax disputes would have a material negative impact on Cameco’s financial resources and would establish significantly higher tax rates going forward.

Cameco’s business profile narrowed in early 2014 with the sale of its interest in nuclear electricity generator Bruce Power Limited Partnership (BPLP), which reduced earnings and cash flow from electricity production. In addition, the Company reduced its fuel services capacity and its investments in fuel enrichment activities have been delayed. The successful ramp up of the much-delayed Cigar Lake project is expected to restore some of the lost earnings power over the medium term, but will more narrowly focus activities on its uranium production and sales activities. The acquisition of NUKEM Energy GmbH will, to a lesser extent, also restore lost earnings although with a tighter focus on uranium production and sales.

Operationally, the Company has performed relatively well, with gross profit before depreciation growing by 5.4% over the last five years to $960 million in 2014 including a more than 50% growth in profitability of its Uranium unit partially offset by the disposition of its Electricity unit and declining Fuel Services unit earnings. Nonetheless, $1.3 billion in growth capex, dividends and $950 million of net acquisitions have led to a $1.1 billion increase in net debt during the period, almost doubling gross interest costs and weakening key financial metrics to the point where many are weak for the Company’s ratings.

First quarter 2015 results were seasonally weak but improved compared to Q1 2014 with earnings from operations before impairments of $73 million, up 55% over Q1 2014 and cash provided by operations net of interest paid of $119 million in Q1 2015, compared to a deficit of $14 million in Q1 2014. Net debt rose by $9 million in Q1 2015 and debt to capitalization was down marginally to 21.5% compared to December 31, 2014. Improved Q1 2015 results in Cameco’s Fuel Services and NUKEM units were partially offset by 5% lower gross profit from its Uranium unit mainly due to higher cost of sales for both mined uranium and uranium purchased for resale. The Uranium unit provided 86% of gross profit, before other corporate items ($132 million) in Q1 2015.

DBRS expects Cameco earnings before non-recurring items to be flat to down in 2015 compared to 2014, due to initially higher costs as Cigar Lake ramps up to full production and with markets that are expected to continue to be weak, in part due to persistent delays in Japanese reactor restarts. Fuel Service and NUKEM volumes are also expected to be soft due to weak market conditions. Interest expenses are expected to rise. Even though growth capex is expected to be reduced, net free cash flow is expected to remain in deficit. With minimal debt maturities, the expected deficit may be funded with cash on hand or short-term credit facilities. These expectations will remain relatively insensitive to spot-market uranium prices, although a strengthening of the Canadian dollar compared to the U.S dollar and any unforeseen expenditures on Cigar Lake during ramp-up may add to the shortfall.

Over the medium-to-longer term, the short fall of uranium mine production compared to consumption, aided by Japanese reactor restarts and the ongoing build of new reactors can be expected to improve the environment for entering into new long-term contracts. Cameco’s earnings power, with the Company’s flexible production capacity, and strong market presence should benefit accordingly but at a pace restricted by its existing contract portfolio.

The combination of the narrowing of Cameco’s business profile, a persistent weakening of several of its key financial metrics to a point that they are weak for the Company’s ratings and the impacts of ongoing uranium market post Fukushima, make a downgrade of the Company’s ratings likely. The Company also remains vulnerable to any unexpected production issues at a key operation, a material set-back in the outlook for nuclear power generation, or the need to make above normal tax payments.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is Rating Companies in the Mining Industry (September 2014), which can be found on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

DBRS will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrs.com.