Teck Resources' Falling Earnings Are Here to Stay

Teck Resources'  (NYSE: TCK  ) results are in, and the numbers are not pretty. Falling prices have taken a big hit on the company's bottom line. Teck is a mid-tier player with some quality mines, but its cost structure is causing headaches.

The damage

Teck's Gross Profit* Q1 2014 (millions of CAD) Q1 2013 (millions of CAD) Change (%)
Coal  292  516  -43
Copper  318  351  -9
Energy  1  1  0
Zinc 121 126 -4
Total  732  994  -26

*Gross profit before depreciation and amortization

Teck is one of the world's largest exporters of coking coal; in recent times prices have headed south, pushing the 43% decline in coal's gross profit. In the past year copper prices have also taken a big hit, pushing down Teck's total gross profit even further.

Coal has its challenges, but Teck should survive 
Falling commodity prices have pushed many in the industry to increase production to compensate for falling profits. Teck is no different, and in the first quarter of 2014, it boosted coal production 8%, copper production 2%, and zinc concentrate production 11% relative to Q1 2013. While boosting production makes sense for a single company, if the entire industry pursues such practices, then the market becomes flooded. These supply boosts are a big reason why Morgan Stanley recently reduced its expected coking and thermal coal prices for 2014 and 2015.

With the huge miner BHP Billiton (NYSE: BHP  ) having grown its metallurgical coal production 24% from the nine-month period ending March relative to the same period one year earlier, soft coal prices should be no surprise. BHP Billiton has pursued this strategy with many other commodities, sending iron ore, thermal coal, and oil and gas production upward. Its diversified business model and fat earnings before interest and taxes margin of 36.5% in the half year ending December mean that it is fully able to continue putting pressure on the coal market.

Even though Teck's coal issues are expected to continue, its balance sheet is not too worrying. It does have a total debt-to-equity ratio of 0.4, but the majority of its long debt is not due until 2020 or later. From now until 2017, it only has $900 million in long-term debt coming due.

Copper has its own difficulties
These Q1 2014 results also highlight Teck's copper challenges. Its copper gross profit fell 9% from Q1 2013 to Q1 2014. Freeport-McMoRan Copper & Gold's  (NYSE: FCX  ) Q4 2013 copper unit net cash costs after byproduct credits were $1.16 per pound, while Teck's Q4 2013 unit cash costs after byproduct credits were $1.57 per pound. Copper prices are around $3 per pound, so there is little to worry about for the time being; but it is worth noting that other producers like Freeport-McMoRan are better positioned than Teck to endure a prolonged downturn.

Energy
Just like its competitors Teck is trying to diversify into energy. In 2014 it expects to spend around CAD $850 million on the Fort Hills oil sands project. This oil sands project is not a quick fix for Teck's profit instability, as first oil is not expected until Q4 2017 at the earliest.

Freeport-McMoRan, on the other hand, has a number of producing wells in California, the Eagle Ford, the Gulf of Mexico, and other places with oil operating costs from $14 to $34 per barrel, great figures for a company that sells much of its energy production Brent and Louisiana Light Sweet pricing.

While Teck's Fort Hills oil sands project is not a knight in shining armor, the project's operator and majority owner Suncor Energy (NYSE: SU  )  is no newcomer to the oil sands. Its collection of established mines and downstream assets let it enjoy a profit margin of 9.7%. With that being said, Suncor's oil sands developments are of a very long-term nature. Fort Hills is expected to have negative cash flow for a notably longer time period than the average U.S. tight oil play.

Fort Hills is expected to take 12 months after first oil to reach production of 162,000 barrels per day. Realistically Fort Hills will not make a big impact on Suncor's or Teck's bottom lines until late 2018 or early 2019.

Teck's next couple years will be challenging
In Q1 2014 falling coal prices took a big hit on Teck's gross profit. Wealthy miners like BHP Billiton are expanding Australian production, and other miners are stuck paying the price.

In addition to coal's challenges, copper prices have hurt Teck. Teck's copper cost structure is higher than Freeport-McMoRan's, suggesting that there is greener grass elsewhere. Teck's spending on its energy continued as planned, but Fort Hills' operator Suncor is clear that the oil sands facility will not see significant production until Q4 2018 at the earliest.

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