Hi Scatterbrain and all, I have been doing some looking into PEN...

Hi Scatterbrain and all,

I have been doing some looking into PEN as I am buying into the U sector presently - mainly the larger TSX listed companies and tier 1 plays such as NXE. However PEN is of interest.

I've attached my quick notes below, which most LT PEN followers already know.

PEN, I think is a little unusual. As you can see below from the Quarterly production/ AIC numbers, whilst production is increasing and costs declining it is still an order of magnitude above their contract prices let alone Spot.

The ability of PEN to source from the spot market to fulfil its contracts is a life saver, albeit a temporary one.

PEN's future rests with the successful permitting and transition to a low pH extraction system.

Until it can obtain these permits (mid 2019) and make the transition ( ??? months subsequent), PEN actually benefits from lower spot U prices as these effectively are a form of cost-of-sales for PEN.

Thus, PEN is a good play now for low spot prices and will benefit from the flip to higher prices only once they sort Lance out. Ideally this flip would occur in 2020 and be sudden and material.

If PEN cannot sort out the high cost of production at Lance then fundamentally it is toast. There is value, however, of its LT contracts to another U sector participant but only whilst spot prices are low.

At current spot prices these sales contract would produce an undiscounted margin of c. US$138m.

As stated below, PEN with an EV of US$38m could 10x bag but it is highly risky. With c. US$19m in cash at present and its Con Note extended till April 2020, the runway has been lengthened for speculators to play these potential outcomes, but I'd suggest it is far from a sure thing (unlike NXE).

Cheers
John


PEN is an ISR U producer based in Wyoming, USA and with a hard rock U JV project in South Africa.

PEN started production at it's Lance project in Dec 2015. The project uses an alkaline based system to extract U from its 53m lb resource base and has a production capacity of 3m lb p.a. although it is currently only producing at an annualized rate of 174k lb and guiding for the next year towards the low 120k lb p.a.

PEN has, as of now, 4.6m lb of sales contracts locked at a price of between US$51-53 between now and 2030. PEN also has an additional 1.9m lb optioned, exercisable by its customers between 2021-2026. These options will likely be exercised if the price of U is higher than the contracted price of $51-53 lb.

In February, PEN announced that they had monetized 935k lb of their contracted U sales deliverable between 2018-2021 in conjunction with a 900k lb purchase contract for U it had secured in the spot market.

The net impact of this was a US$19m cash injection to PEN after c. US$3.8m VAT bill.

This represents the margin that PEN would have made by selling into the sales contracts with the purchased U and applying a discount rate for the financier of the deal.

PEN's issue is that the Lance Project is not responding as expected to the alkaline process and recovery rates and U production are materially lower than projected in the BFS.

To illustrate, the costs of production on an AIC basis are as follows:

Q1 2017
Production 25.3k lb
AIC US$298 lb

Q2 2017
Production 30.6k lb
AIC US$200 lb

Q3 2017
Production 34.5k lb
AIC US$152 lb

Q4 2017
Production 38.8k lb
AIC US$107 lb

Q1 2018
Production 43.6k lb
AIC US$73 lb

So, whilst you can see that production is improving each quarter and costs are coming down, they are still materially higher than the contracted price let alone the spot price.

PEN has recently (April 2018) submitted an application to change from an alkaline to a low pH (acid) extraction system that will require little capex to modify their system and, according to PEN drop their cost of production to the lowest Quartile in a "game changer" for the Company.

PEN believe that there are no impediments to this process and "reasonably expect" that the permits will be granted by mid 2019.

Until that point, PEN will limit production from its high cost Lance project and supplement contract deliveries from spot market purchases - a totally sensible decision based on their current cost of production.

As part of this, PEN have halted all further wellhead developments (currently 10 header houses) and thus capex.

At 4.6m lb of contracted and obligated sales at between US$51-53 lb for the next 12 years (2030) PEN have a viable cashflow if this can be sourced from the spot market, allowing a c. current margin of $30 lb at current spot rates.

PEN currently has US$19.3m in available cash post its monetized transaction discussed above (it has additional cash held as security bonds).

Against this PEN has a Convertible Note of US$17m, the maturity of which has recently been extended till April 2020. The key terms of the Con Note are:

- Converts at 40c per share
- 10% p.a. interest increasing to 12% p.a. in second year
- 22.5m Options exercisable at 50c

PEN's liquidity is safe enough for the next couple of years until the Con Note matures. Note that PEN won't be selling any U until Oct 2018 so will be draining its cash reserves until that point.

If the permitting process goes according to the timeline anticipated and the decision is favourable, PEN should by that point in time be able to demonstrate material cost reductions (U recoveries and production much higher) relative to present (improving) rates and thus roll the Con Note or, if the SP is high enough see it converted into shares.

PEN has 4.6m lb of sales contracts out to 2030 (assumed evenly apportioned at 383k p.a.) currently providing c. $30lb margin for a gross margin of US$138m undiscounted.

That assumes no upward movement in spot U prices.

PEN is exiting their South African hard rock JV (74%) as there is no prospect of developing or selling the project in the current market and the holding costs are prohibitive.

PEN has an EV of A$55m which reflects its troubled production issues at Lance and depressed sector.

This is much lower than the NPV of its "in the money" sales contracts now that PEN can access the spot market to meet delivery obligations (vs. its high cost Lance project).

The EV also doesn't take into account any upside if PEN can successfully transition from an alkaline to acid based ISR system although there are both regulatory and operational risks here.

PEN has 53m lb of U resources within its USA based Lance Project and would benefit from any Government policy changes in terms of U being deemed a critical material and "protected".

In a worst case scenario and spot prices remain low and the Lance project is either unsuccessful in getting permits or cannot transition operationally then the 4.6m lb of US$51-53 lb contracted U would have significant value to another sector participant in a liquidation situation.

Thus, at a price of A$0.25c (EV A$55m or US$38m) this is worth some speculative money if an investor thinks that:

- The U market will turn around at some point in the next few years AND
- That the Lance project will be able to obtain permitting to change from alkaline to acid production AND
- That PEN can successfully transition and bring costs of production down materially to the 1st Quartile.

It is, however, much more risky than say, NXE, but being in production will benefit during this cycle from a U price spike and at an EV of just US$38m for (a) producing project (b) 53m lb R&R (c) 4.6m lb of $51-53 lb sales contracts means that PEN could be a 10x bagger over the next few years.

It could also be a zero.