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TCK - Teck Resources


Patmo
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China’s economic rut significantly dislocated the supply/demand dynamics of commodities temporarily, taking share prices of commodity producers down to the basement with them. This creates an interesting opportunity for potential value investments. I believe Teck Resources is one of them.

 

Teck is Canada’s largest (diversified) resources company, dealing primarily in copper, coal and zinc in addition to assets in lead, gold/silver, bitumen, etc. The company is facing similar conditions to the GFC, and the thesis for an investment in the company’s equity is simple: Teck will successfully deal with the current situation in a similar way that it did back then, and the public market does not give the company credit for it. The company has already done an excellent job in 2015 of navigating the downturn in commodity prices, and there is no reason to suspect this will change going forward.

 

Share price recently rebounded sharply, however I believe there is still a fat amount of value to be extracted from this opportunity. I have conducted a detailed analysis and concluded that this company is worth roughly $30 to $35 per share on a normalized basis, and shares currently trade at $4.30 on the public markets. Successful outcome of this investment could result in a 7bagger before the end of the decade, with enough assets in place to protect part of our initial investment in the unlikely case of failure.

 

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China’s economic rut significantly dislocated the supply/demand dynamics of commodities temporarily, taking share prices of commodity producers down to the basement with them. This creates an interesting opportunity for potential value investments. I believe Teck Resources is one of them.

 

Teck is Canada’s largest (diversified) resources company, dealing primarily in copper, coal and zinc in addition to assets in lead, gold/silver, bitumen, etc. The company is facing similar conditions to the GFC, and the thesis for an investment in the company’s equity is simple: Teck will successfully deal with the current situation in a similar way that it did back then, and the public market does not give the company credit for it. The company has already done an excellent job in 2015 of navigating the downturn in commodity prices, and there is no reason to suspect this will change going forward.

 

Share price recently rebounded sharply, however I believe there is still a fat amount of value to be extracted from this opportunity. I have conducted a detailed analysis and concluded that this company is worth roughly $30 to $35 per share on a normalized basis, and shares currently trade at $4.30 on the public markets. Successful outcome of this investment could result in a 7bagger before the end of the decade, with enough assets in place to protect part of our initial investment in the unlikely case of failure.

 

Here's financial data from their Q3 15 report (CAD$):

 

Q3'15Q2'15Q1'15Q4'14Q3'14Q2'14Q1'14Q4'13Q3'13
Revenues$2,101$1,999$2,024$2,256$2,250$2,009$2,084$2,376$2,524
Gross profit339311348416414298407546597
EBITDA(2,506)596546582651558557766815

 

Total Debt: $9.6B

Cash: $1.5B

Net Debt: $8.1B

 

Shares outstanding: 576M

Share Price: $6

Market cap: $3.5B

 

Enterprise Value: $11.6B

 

If you ignore that EBITDA was negative in Q3, you get EBITDA of ~$2B. That gives you EV/EBITDA of 6x. I don't think one can ignore that EBITDA has become negative (since they could start violating debt covenants). To say, it is worth 7x of current price, we are saying that EBITDA can grow - which I don't see how without a recovery in commodity prices - or that it is deeply undervalued. At 5x EV/EBITDA, I don't think it is undervalued at all. A commodity producer, no matter how good, is not worth 10x EV/EBITDA.

 

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The problem isn't cheapness on a normalized EV/Ebitda basis - its how many shares there will be.  If you think they muddle through without equity and met coal turns in some reasonable horizon its absolutely very cheap.  But that's also completely un-underwriteable.  Steel demamd is weak and getting weaker and the Australians and Mozambique are still ramping met coal production below teck. Not to mention the Chinese probably become net exporters sooner or later.

 

It's tough is what I'm saying.  What's the debt trade at?

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Hi Patmo, Thanks for bringing up the idea.  I have also been looking at Potash (I actually bought a small amount and sold out the next day - some indecision on my part).  In relation to

Teck, I use to hold Fording Coal, and Sherritt International, some of which Teck has eaten along the way.

 

I am by no means an expert on mining production..  However, I have observed that the cycles are deep and very long on the downside.  Most of the time mining companies operate in this sort of "race to the cheapest production" environment, barely getting by.  About once every couple of decades supply becomes constrained and suddenly the prices skyrocket and everyone makes a killing. 

 

IMO, we are very early in the retrenchment for base metals.  A huge amount of capacity will need to come off line before prices rise enough to reach your 7 bagger moment.  The implosion began about the time of the Beijing Olympics - 8 years ago.  Of course, projects were still coming online for a few years after.  Now we are firmly in retrenchment but it is going to last for years. 

 

Teck is going to struggle for that whole time, and as others have mentioned there will likely be equity dilution along the way.  The  problem for Teck is that only metallurgical coal is actually consumed.  Copper and Zinc still exist and my read is that there is alot in storage that needs to be drawn down. 

 

With Potash, since I mentioned it, at least the product disappears after purchase, much like oil.  But I am in no hurry to enter this either.

 

While an intriguing idea, I think we are years early on this. 

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The company is on the overvalued side.  The cash flow is bad once you factor in the capitalizing of stripping costs (which is really something that should be expensed; the accounting rules are stupid and Teck is bending them).

 

The oil sands is not economic... it won't have positive cash flow, let alone return its upfront capex.  They should put it on care and maintenance if they haven't already.

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Hi Patmo, Thanks for bringing up the idea.  I have also been looking at Potash (I actually bought a small amount and sold out the next day - some indecision on my part).  In relation to

Teck, I use to hold Fording Coal, and Sherritt International, some of which Teck has eaten along the way.

 

I am by no means an expert on mining production..  However, I have observed that the cycles are deep and very long on the downside.  Most of the time mining companies operate in this sort of "race to the cheapest production" environment, barely getting by.  About once every couple of decades supply becomes constrained and suddenly the prices skyrocket and everyone makes a killing. 

 

IMO, we are very early in the retrenchment for base metals.  A huge amount of capacity will need to come off line before prices rise enough to reach your 7 bagger moment.  The implosion began about the time of the Beijing Olympics - 8 years ago.  Of course, projects were still coming online for a few years after.  Now we are firmly in retrenchment but it is going to last for years. 

 

Teck is going to struggle for that whole time, and as others have mentioned there will likely be equity dilution along the way.  The  problem for Teck is that only metallurgical coal is actually consumed.  Copper and Zinc still exist and my read is that there is alot in storage that needs to be drawn down. 

 

With Potash, since I mentioned it, at least the product disappears after purchase, much like oil.  But I am in no hurry to enter this either.

 

While an intriguing idea, I think we are years early on this.

 

Hi Uccmal,

 

Thanks for your thoughts. I agree on the commodity cycle's position, but I feel the share price hasn't followed it - it pushed through and crashed straight to the ground. In other words share price may not go far past its recent bottom in the coming years even if the situation plays out as you described. I feel we are in a solid entry point but I personally leave two more rounds in the chamber to potentially average down at my leisure. I wouldn't fault anyone for waiting for an even lower entry point though, to paraphrase Bill Miller, he who has the lowest cost basis wins.

 

If you're looking at potash, you might want to have a look at Karnalyte Resources. It's a way better risk/reward than Teck imo, but not alot of people would be comfortable owning a single property that is not developed yet, especially one that requires as much financing as a potash project in a tough credit environment.

 

 

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The problem isn't cheapness on a normalized EV/Ebitda basis - its how many shares there will be.  If you think they muddle through without equity and met coal turns in some reasonable horizon its absolutely very cheap.  But that's also completely un-underwriteable.  Steel demamd is weak and getting weaker and the Australians and Mozambique are still ramping met coal production below teck. Not to mention the Chinese probably become net exporters sooner or later.

 

It's tough is what I'm saying.  What's the debt trade at?

 

Equity dilution is a clear risk to equity holders. During the GFC they issued approx. 40% of class B shares in a private placement at $15ps to pay down some debt. However this clearly did not justify the share price to get to $4 at the time, as it went from $4 to $60 within 2 years, trough-to-peak. The situation is very similar now, and the recent trough value ended up in the exact same range as trough value at that time too, in terms of reported NAV per share.

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  • 4 months later...

Anybody still following Teck? Share price went up substantially since I presented the idea, and there seems to be some price momentum going into the upcoming earnings release Jul 28th.

 

They recently closed refinancing of 1.25bil in various debt due 2016-2019 with 5 and 8 year notes. Also extended $1bil credit facility from 2017 to 2019. Pretty good news for equity holders lately

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I've looked at Teck recently. Couple interesting points:

 

1) largest equity holder is a unit of China Investment Corp ... believe they have a 20% stake...

 

2) Energy Investment: They've spent about 3-4bn in capex developing an oil sands project over the past ~3yrs (Fort Hills) along with Suncor (in which Berkshire has an investment, not sure who made it though). That should be fully ramped up in late 2017 ... not sure it will be profitable unless oil prices rise substantially, even from today's levels. 

-> Oil sands positives: 2nd largest reserves in the world, very long lived, Canada generally considered a "safer" place to invest vs. lots of other oil producing countries. Negative: Break-even (including operating and transportation/blending costs) are some of the highest in the world anywhere from 50-70 WTI depending on which player... due to poor infrastructure/govt. royalties/technology investment required.

 

3) Bright spot for TCK could be Zinc, couple reports recently talking about supply actually going down due to mine closures around the world..

 

4) Coal/Copper markets probably will take more time to recover...

 

5) Don't like the accounting/covenants - leverage is high and you'll prob see them issue more guaranteed debt, on top of the old non-guaranteed debt/ so leverage likely to go up in 2016/17 while not sure EBITDA will recover substantially.

 

6) I would say the bull-case rests on the fact that this is one of the largest Canadian resource companies, meaning the government/banks will probably support them (already the case, you can see in loose covenants/they reinstated a dividend, and did not raise equity). The China investment, not sure what to make of it... I think the grades of coal that they produce are better than the ones in China.

 

They do have a large asset base..

 

Not sure there is a lot of upside from today's price unless zinc prices move up substantially...

 

 

 

 

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  • 3 years later...

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