Teck Resources Ltd Looks Strong on the Met Coal Side

Teck Resources' cost performance will allow the company to profit from the met coal price upside cycle when it finally happens.

Apr 26, 2014 at 12:15PM

As Teck Resources (NYSE:TCK) produces both met coal and copper, its earnings took a hit in the first quarter. Copper prices took a dive in March, while met coal prices continued their long-term downtrend. As a result, the company missed earnings estimates by 25%. However, Teck Resources was still profitable, which is a rare case for a miner with met coal in its production mix. What's more, met coal could be a driver for future upside.

Strong cost performance brings hope for the future
Teck Resources' met coal costs are among the lowest in the industry, which allows the company's coal segment to remain cash flow positive even in the current met coal price environment. This fact could play a major role in the future company's performance when weaker players leave the market.

Teck Resources estimates that as much as 35 million to 40 million tons of global seaborne traded met coal is currently produced at a negative cash margin. Of course, this situation is not sustainable in the long term. However, it could stay like that for some time while producers manage to get financing for their money-losing mines.

During the earnings call, Arch Coal's (NYSE:ACI) CEO John Eaves estimated that there were 15 million-25 million tons of excess supply on the 325 million ton met coal market. Teck Resources' estimates are more modest, as the company's CEO Donald Lindsay estimated the surplus at 12 million-15 million tons.

The key takeaway from these two estimates is that the market doesn't need to get rid of all uneconomic production to become balanced. In fact, if just a half of negative-margin production leaves the market, the prices will rise. The question of timing remains important, as uneconomical production could be sustained for a prolonged period of time if provided with additional financing.

No production cuts on the met coal side
Meanwhile, Teck Resources increased its met coal production by almost 500,000 tons in the first quarter. During the earnings call, the company straightforwardly stated that it is not going to cut production to help its weaker competitors stay in the business. Just like BHP Billiton (NYSE:BHP), Teck Resources wants to secure greater market share.

However, unlike BHP Billiton, which still has several met coal projects in the pipeline, Teck Resources decided to defer the potential restart of the Quintette met coal mine and put it on care and maintenance. Instead, Teck Resources is focused on bringing its costs further down, and targets C$200 million in additional annual operating cost reductions.

Teck Resources' strength lies in the fact that the company doesn't have to buy time. While its earnings are under pressure with soft met coal and copper prices, the company remains profitable. What's more, the company's third segment, zinc production, delivers stable results. Its average realized price for zinc fell just 2% from the first quarter of 2013, while copper lost 8% and met coal was down 11%.

Bottom line
Teck Resources is well positioned for the upside in the met coal price cycle, but there's still a long time before supply and demand become balanced in the met coal market. Therefore, the company's results will remain under pressure in the near term.

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Vladimir Zernov has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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