The Case For Investing In USEC, Inc.: "Take A Long View"

In their 2009 Annual Report, USEC, Inc. attempts to put the lipstick on what appears at first glace to be their pig employing the theme "taking the long view." However, a little delving into some of the facts at USEC, Inc. shows that there are some interesting things about the company that might point to it being undervalued.

USEC, Inc. (USU on the NYSE) is a leading supplier of low enriched Uranium (LEU) which is the key feedstock in the manufacture of fuel assemblies for commercial nuclear power plants.

USEC, Inc. has what to many analysts are some clear problems:

1. The Paducah Gaseous Diffusion Plant: USU leases the Paducah GDP from the U.S. Department of Energy. Gaseous diffusion as a means of industrially refining LEU is incredibly electricity intensive.

USU claims that electricity costs alone represent 70% of the production costs of LEU. Traditionally, USU has had long term contracts at special rates with the Tennessee Valley Authority (TVA). However, the burdens of environmental compliance upon the TVA as well as their requirements for capital spending will surely mean an increase in rates for USU going forward as new contracts are let.

According to USU, "Negotiating a reasonably priced extension of our power contract will be the key factor in how long operations at our Paducah plant will be competitive."

Power costs are already eroding USU's profits. If you thought you had problems, the electric bill for the Paducah GDP last year alone was $700 million!!!

2. The American Centrifuge Project (ACP): Recognizing that a good chunk their future profits were tied to reducing manufacturing costs, USU licensed the technology for the ACP from the Department of Energy several years ago and has invested $1.7 billion into the project since.

USU claims that successful deployment of the ACP will reduce electricity consumption in enriching LEU by 95%.

To advance the ACP program, USU applied for $2 billion in loan guarantees from the DOE. In mid 2009, the application for those guarantees was held up. After more research, a decision should be forthcoming in the first half of this year. Naturally, many people consider this issue to be a tremendous black cloud over USEC, Inc.'s future.

Much of the ink regarding bad news surrounding USU revolves around these two points to some degree or another. Naturally, given the nature of USU's business, there are other risks but they do not seem to command nearly as much attention.

Now, to take a long view:

First, USU has an $8 billion backlog. Since many of their contracts are for five and ten years, this should translate into some consistency in earnings in the future.

Secondly, USU is a major player in the LEU business with an established footprint: they are said to supply 50% of U.S. demand and 25% of global demand. There are currently 440 reactors operating worldwide with 53 under construction. Furthermore, according to the World Nuclear Association (an industry group and propaganda organ) there are 100 reactors planned/on order and hundreds more proposed). Clearly, there is room for USU to expand its sales.

Thirdly, the Paducah GDP is reliant on Freon for cooling purposes. USU claims that the supply of Freon at Paducah is sufficient to the end of the decade. At that point, the Paducah GDP, the only currently operating enrichment facility in the United States, will most likely have to close.

Freon recovery and spare parts from the now closed Portsmouth Gaseous Diffusion Plant in Piketon, Ohio could extend the life of the Paducah GDP but there are issues and that source is still finite.

In essence, the ACP needs to move forward or the U.S. might become dependent on imported LEU. There are a lot of dim bulbs in Washington and on Capitol Hill, but they certainly cannot be so short sighted as to allow a good chunk of U.S. electricity production to become hostage to foreign vendors...one would hope.

Fourthly,USU has a real sweet contract clause with the Department of Energy: when the time comes, USU can walk away from Portsmouth and Paducah leaving them "as is" outside of any contamination directly attributed to their activities. It is difficult to put a dollar value on this fact, but it can no doubt be substantial.

Finally, consider that Usec, Inc. is a privatized piece of the Department of Energy. Though I have no figures, it is probably safe to assume that the amount of money the government invested in what was eventually spun off is probably more substantial than what USU appears to be worth. No figures but just a hunch!

DISCLOSURE: Yes, I am long in Usec, Inc. and a couple of other players not mentioned herein.