Teck Resources' Cash Flows Could Be in Danger This Year

The lack of production growth in combination with the rise in capital spending could lead to a negative free cash flow for Teck Resources.

Feb 19, 2014 at 10:59AM

Sometimes even diversification doesn't help to avoid difficulties. This has been the case for Teck Resources (NYSE:TCK), which produces coal, copper, and zinc. Teck Resources achieved record coal sales and second highest yearly copper production in 2013, but it didn't help the bottom line as prices for these materials declined. It looks like the difficult price environment will continue to pressure the company this year.

Production will be stagnant in 2014
Teck Resources' revenue stream is fairly evenly distributed between three main sources. Coal accounted for 43.8% of revenue in 2013, while copper brought 30.4% of revenue and zinc brought 25.7% of revenue.

The company expects 2014 coal production of 26 million – 27 million tons, a modest increase from the previous year's level of 25.6 million tons. Teck Resources has the capacity to produce up to 28 million tons of coal, and could do so in the case of a favorable market environment.

Copper production is expected to decline. The company expects to produce 320,000 – 340,000 tons of copper, down from 364,000 tons in 2013. Zinc production is projected to stay at the previous year's levels. The absence of meaningful production growth will result in stagnant revenue levels.

Oil sands project leads to increase in capital spending
At the same time, Teck Resources lifted its 2014 capital expenditures by 40%. The main part of the increase came from the company's investment in the Fort Hills oil sands project, which it is developing together with partners Suncor Energy (NYSE:SU) and Total.

Suncor expects that its 2014 production levels will be lower than in 2013 as the company lost almost all oil production from Libya as a result of ongoing labor strikes. A solid production stream from an asset in a safe jurisdiction would have been a perfect substitute for the lost barrels. However, Suncor will have to wait until 2017 when the first oil from Fort Hills is expected.

Fort Hills will require $2.94 billion of capital investment from Teck Resources over the four years from 2014 to 2017. In the current year, the project will require $850 million. When Fort Hills starts producing, Teck Resources' share of production is expected to be 36,000 barrels of bitumen per day. Lately, bitumen prices have been under pressure. Suncor received $59.45 per barrel of bitumen in the fourth quarter. At such prices, Teck Resources' share of Fort Hills production will contribute less than $800 million per year in the future.

Teck Resources is not the first mining company to go into the oil business. Copper producer Freeport-McMoRan (NYSE:FCX) acquired Plains Exploration & Production and McMoRan Exploration back in 2013. As a result of this move, Freeport-McMoRan achieved production of 16.6 million barrels of oil equivalent in the fourth quarter with healthy margins.

Cash flows will come under pressure
The lack of production growth will negatively affect Teck Resources' revenue growth. Prices for coal, copper, and zinc remain at depressed levels, and this means that operational cash flow is unlikely to demonstrate significant growth.

At the same time, capital expenditures will be significantly higher than in 2013. Also, Teck Resources maintained its dividend. The company spent as much as $521 million on the dividend in 2013. It is possible that Teck Resources will have negative free cash flow in 2014, as expenditures continue to rise while revenue remains stagnant.

Teck Resources' long-term growth is dependent on the success of the Fort Hills project. However, this project will not be finished until 2017. In the near term, the company remains dependent on materials prices, and this means that its shares could see some weakness.

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Vladimir Zernov has no position in any stocks mentioned. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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