Teck Resources (TCK 3.55%) is the second largest premium low-volume coking coal player, a top 10 copper producer (in the Americas), and a top 3 zinc producer. Flying under the radar is Teck's emerging energy segment, which could become a meaningful contributor to profits later this decade. In my opinion, the market gives little credit to Teck's zinc assets and no credit at all to its Fort Hills joint venture oil sands project with Suncor Energy (SU +0.43%).
Teck is perhaps most known for its high-quality coking coal franchise. This segment is under severe pressure as the benchmark coking coal price as measured by an Australian quarterly index is down from $330 per metric ton in mid 2011 to $120 per ton.
In an April conference call, Teck's CEO Don Lindsay had this to say:
...prices clearly remain weak, particularly for steelmaking coal. Coal prices are currently at their lowest level since 2007, and margins are at their lowest level in 10 years. We estimate that as much as 35 million to 40 million tonnes of global seaborne traded steelmaking coal is currently being produced at a negative cash margin.
Coking coal prices have been extremely weak for quite some time, longer than many market pundits thought possible. Teck's management team believes that the depressed level of $120 per ton is unsustainable. I agree. There's simply too much marginal supply, especially in China, at costs at or above $120 per ton.
Teck's operating performance has held up
Despite very weak coking coal prices and a real drag on earnings, Teck's operating metrics have held up reasonably well. Importantly, unlike several other coal and iron ore producers, Teck is not burdened with excessive debt. In fact, Teck has been able to maintain a generous dividend and is currently yielding almost 4%. Teck's enterprise value (market cap + debt-cash) to earnings before interest, taxes, depreciation, and amortization (EBITDA) ratio is a reasonable 7.4 times, especially as the company's energy assets are not reflected in that metric.
Comparing Teck's financial strength to that of coal producers such as Walter Energy (WLT +0.00%), Cliffs Natural Resources (CLF 0.41%), and Peabody Energy (BTU +0.00%) is an eye-opener. Walter and Peabody have high debt-to-EBITDA ratios, 20.6 times for Walter and 11.4 times for Peabody. Cliffs has very weak operating margins with iron ore prices at $90 per ton (down 33% this year). As an aside, Cliffs has a 4.2% dividend yield, but I think that dividend could be in jeopardy.
Teck's hidden asset is looking good with elevated oil prices
Teck's energy segment is a work in progress. The company has a joint venture with the strongest oil sands player on the planet. Oil sands projects are highly attractive because they can deliver decades of non-declining oil production. The cost of entry into a world-class oil sands project is high, though. That's why Teck is well positioned with its partnership with Suncor. According to Teck's most recent corporate presentation, Suncor has completed four $20 billion oil sands projects at or under budget.
Oil prices are currently strong due to tensions in Iraq, but even before the Iraq flare-up, oil prices have been quite steady around $100 per barrel. In fact, oil prices have been largely in the $90-$105 range for the past three years. This may not seem like a big deal, but compared to uranium, gold, coking coal, and iron ore, oil is a star performer.
Oil sands projects are spectacular in the sense that there's virtually no decline curve. A project like Teck's could well be in production for decades. A lot of capital has been sunk into the joint venture, and there's plenty more to go. This is a very valuable asset that is worth billions, however, and it's one that the company gets little to no credit for. That will surely change in the next few years, along with an inevitable rebound in coking coal. When the market recognizes the scale and quality of Teck's hidden energy play, the company's stock could be rerated higher. This is not a high risk/high reward play, but instead is a company with a 3.9% yield that could have 50% upside over the next two years.
