After several tough years, commodity prices were up substantially at the start of 2017. Steelmaking coal, for example, had almost tripled from where it was a year ago, while copper and zinc prices were up 25% and 66%, respectively. Those higher prices were a boon for diversified Canadian miner Teck Resources (TECK 4.40%), which generated a heap of cash flow during the first quarter.
The company had the flexibility to do whatever it wanted with that cash flow. However, instead of squandering it on empire building, which many companies tend to do, Teck brilliantly allocated its windfall to pay down debt and reward shareholders with a sustainable dividend policy.
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Shoring up the balance sheet
Due to falling commodity prices and high capital spending from new mine development, Teck Resources has had to borrow billions of dollars in recent years to bridge the gap between its capital expenditures and cash flow. At its peak, Teck had more than $7 billion in debt outstanding, which caused its leverage ratio to rise, resulting in the company not only losing its investment-grade credit rating but getting downgraded deep into junk territory.
However, thanks to some non-core asset sales and its strong cash flow in recent quarters, Teck Resources has been slowly shoring up its financial situation. During the first quarter, for example, the company generated 1.3 billion Canadian dollars ($1 billion) of cash flow from operations, which was up from just CA$373 million ($288 million) in the year-ago period. The company took that cash flow and retired $1 billion of debt during the quarter and has now paid off $2.1 billion in debt over the past year and a half. Those repayments dropped its outstanding debt down to $5.1 billion at the end of the first quarter and improved its debt to debt-plus-equity ratio from 36% to 27%.
Teck would go on to pay off another $214 million in debt during the second quarter, which will save it about $10 million per year in interest expenses. As a result, the company has minimal debt maturing over the next five years.
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Giving shareholders a raise
With its balance sheet getting back on solid ground thanks to the debt repayments -- which will save the company tens of millions per year in interest expenses -- Teck now has greater financial flexibility to return more cash to shareholders. That led the company to unveil a new dividend policy in April. That plan will see the company pay a base dividend that's double its prior rate. Furthermore, Teck will review its financial situation at the end of each year and will pay a supplemental dividend if conditions permit.
That semivariable dividend policy is similar to those of other mining companies, which are going this route to balance cash returns to investors with the volatility of commodity prices. Diversified global mining giants Rio Tinto (RIO 1.43%) and BHP Billiton (BHP 2.04%), for example, are paying base dividends based on cash flow. In Rio Tinto's case, it plans to pay out 40%-60% of its annual cash flow to investors via dividends. Meanwhile, BHP Billiton's policy is to pay out a minimum of 50% of its cash flow after maintenance capex in dividends, with the potential to pay out an additional dividend from the other 50% of cash flow depending on how it chooses to allocate that capital. For example, BHP Billiton's last dividend was $0.40 per share, which consisted of a $0.30-per-share minimum payout and an additional payment of $0.10 per share. Those policies are very shareholder friendly, which is why both Rio Tinto and BHP Billiton are two of the top dividend stocks in the metals and mining industry. While Teck Resources' dividend isn't in their league yet, it does have substantial upside potential via future supplemental dividends.
Investor takeaway
Teck Resources took full advantage of higher commodity prices earlier this year to pay off a big chunk of the debt that had been weighing it down. That brilliant move enabled the company to free up cash flow that it can now use to pay a higher dividend. However, instead of locking itself into a high fixed rate, it made the smart move to pay a lower flat rate with the option for a higher supplemental dividend if conditions allow. These wise moves put Teck in a stronger position to weather the unpredictable nature of commodity prices.
