Monday, July 2, 2012

DNN: Something different

A week split by a Wednesday holiday means that business is definitely not as usual. It seems like a good week to get off of the big cap track that I usually walk in favor of a trail less traveled: A penny stock.

And not just a penny stock, but a commodities-related penny stock in a Canadian company that mines and refines a product that makes most people very, very nervous.

Like a great big firecracker, it is a metal that sometimes goes Boom!

Denison Mines Corp. (DNN) exploits uranium deposits in Colorado, Utah, Arizona and Saskatchewan. The Toronto, Ontario company also owns four uranium mills, runs recycling operations and is involved in development not only in North America but in Zambia and Mongolia.

The company trades on the American stock exchange as DNN, but also on the Toronto exchange, as DML.

DNN has a truly awful chart. This is not a stock for bullish trend following. The financials are pretty dismal. It's not a stock for the growth investor. The options are such that I wouldn't want to trade them, so any play on DNN is a straight bet, with no hedging.

It is probably the most speculative play I've ever written about in this space.

Yet, DNN landed today as a top buy recommendation by a major stock rating company, and one brokerage has also rated it as a strong buy.

So arguably, there is something going on with DNN. The question for me is whether I should make room for this stock in a corner of my portfolio.

DNN has been on a downward slide since May 3, when it opend at $1.94. It hit a swing low of $1.33 on May 17, swung up to a lower high of $1.71 on May 29, and then zig-zagged lower to today's lower low of $1.22.

This leg down is part of a larger downward slide that began Feb. 14, 2011 at $4.52. Although the present move must be counted as a downtrend on the daily chart, it has yet to hit a lower low on the weekly chart. It would need slide below 81 cents to be unambiguously in a weeky-chart downtrend.

But no matter what the rationale, this is a stock that has clearly been beaten down for more than a year, with no sign on the chart of recovery.

DNN has a negative return on equity of 25%. That comes with no long-term debt.

Institutions own 14% of shares, and the price, even at these low levels, has been bid up to the point where it takes $5.34 in shares to control a dollar in sales.

Denison has made a profit in only one of the last 12 quarters. Six of those quarters saw upside earnings surprises, and five surprised to the downside.

My analysts enthusiasm index rates DNN at negative 40%. But -- at last, a positive note -- that's up from negative 50% a month ago.

So far so bad. 

Uranium, like gold, is one of those commodities that lends itself to stories. The stories behind uranium are 1) fear, from Three Mile Island in 1979 through Chernobyl in 1986 to Fukushima just last year, and 2) the need for clean energy in a warming world.

One thing to note about that fearful list of major disasters is their absence for a quarter of a century between Chernobyl and Fukushima. And something to think about regarding clean energy is whether there are reasonable alternatives to nuclear.

If global warming caused by human agency is a fact, as most climatologists believe, then there will be a huge demand for clean energy in the very near future. The studies I've seen suggest that solar and other green fuels will fall far short of being able to close the energy gap. That leaves nuclear, fueled by uranium, as the likely dominant energy source for the mid-term.

That, at least, is how the story goes. And if I buy it, then I would have to conclude that I need some nuclear related shares in order to have a well diversified set of holdings.

And I'm guessing that the optimistic analysts are thinking along those same lines, although with a lot more detail about Denison's mining operations, management skills and ability to function profitably in the market.

The DNN options selection is quite small with very wide bid/ask spreads and yet with high open interest on some strikes, up to four figures. This tells me at speculation is rampant.

Option volume is running at more than double its five-day moving average for calls, which are bullish. Puts, by contrast, are trading at only about a third of the five-day average volume. That tells me that the speculation is to the upside.

Implied volatility stands at 104%, an extremely high level. That, of course, is one attraction of penny stocks: They're very volatile, so they provide some of the biggest profits available absent any leverage. Yet the volatility is at its lowest level of the past six months, and has been falling since April.

Options are pricing in confidence that 68.2% of trades over the next month will range from 88 cents to $1.62, for a maximum gain or loss of 30%.

The stock is trading below the fair price range of the last five days. The range encompasses 68.2% of trades and runs from $1l28 to $1.34, with the most trades occurring at $1.32.

DNN on average trades 661,000 shares a day. The company next publishes earnings on Aug. 2.

Decision for my account: The cautious trader would wait for some sort of upside move before entering. (Actually, the really cautious trader wouldn't touch this stock with a 10-foot pole!) The problem with waiting for an upside move is the volatility: This stock can burn a lot of percentage  change in a day, and the cautious trader may miss the rise.

Looking only at the last three days, we had a lower low, followed by an upward gap and a higher high from two days earlier, and then a downward gap and a lower low today. Today's trading has retraced about half of its intra-day fall.

If I were to wait for an upward sign, I would want to see a break above $1.35 (the June 29 high) before entering. If I entered now, I would set a stop/loss at $1.06, which is double the average daily range of 7.89 cents.

Another consideration is diversification: A play this far from my usual practice is a diversification move, and diversification is never a bad thing.

What will actually do? I don't know yet. The high volume of call options interests me, as does the analyst picture. The chart and the financials -- not so much. I'll post a brief notice here on Private Trader if I do decide to trade DNN.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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