Teck Resources’ Balance Sheet Strength Gives It A Valuation Edge – Teck Resources Limited (NYSE:TECK)

Teck Resources Ltd. (TECK) is a diversified explorer, developer and producer of many base metals, though primarily focused on coal, copper and zinc. Like most commodity and precious metal producers, it is highly susceptible to the prices of its underlying commodities. This can be a double edged sword, with profits and cash flow very high during periods of high pricing with high stress when global surpluses cause low pricing. This is one reason why commodity companies often trade at substantial discounts to other operative businesses as the volatility is not prized among investors. Teck is no different but trades at a sharp discount to its larger competitors.

Two relatively recent Seeking Alpha articles discussed Teck’s performance here and here. They give a good overview of the company and its operative performance. I want to look at the downside risk for the company. It is hard not to see the macro risks in the news daily with tariffs being threatened on a multitude of international trade fronts. This has largely been focused on value added products but it is unknown how it will evolve at this time. The uncertainty it brings though is an overhang on companies dependent on a robust economy, as Teck is.

Teck’s operations are largely based in the Americas, both North and South.

Source: Teck Company Presentation, June 7, 2019

It also has a diversified customer base with its 2018 revenues geographically split as follows:

Teck Resources' Balance Sheet Strength Gives It A Valuation Edge - Teck Resources Limited (NYSE:TECK)

Source: Teck Company Presentation, June 7, 2019

With 20% of its revenues sourced into the United States, there is certainly a risk to these revenues should tariffs be applied to the importation of base metals. At this point, despite the fact NAFTA was to be renegotiated, there has been no real change so far. A draft version is being tabled, but at this point the risk of tariffs impacting Teck’s basic business is minimal as it has diverse enough operations to meet demand. This obviously can’t be assured in the event of an overall global slowdown in business activity but companies beyond Teck itself will be impacted. If you are making an investment in Teck or any of its larger competitors, this is a known risk.

Teck has a diversified product base, though it is still a majority coal producer:

Teck Resources' Balance Sheet Strength Gives It A Valuation Edge - Teck Resources Limited (NYSE:TECK)

Source: Company Presentation, RBC Conference, June 7, 2019

I want to focus on Teck’s debt profile and how it compares to these larger companies. This is more a test to how robust the company can be in the event of a decline in commodity prices or a tightening lending environment. Admittedly, Teck was recently able to obtain a substantial $2.5B financing line for its QB2 copper project in Chile so at the moment lending would appear to be available for commodity projects. The project has strong projected financial metrics based on current assumptions. Teck took the opportunity to sell off 30% of the project to Sumitomo and put the QB2 into a joint venture. The above financing was secured by this project so has nominal recourse to Teck.

Debt Structure

Teck had issues long ago with over-leveraging itself; this was put largely in the rearview mirror when I last looked at the company over three years ago. The table below is Teck’s current long term debt structure:

Teck Resources' Balance Sheet Strength Gives It A Valuation Edge - Teck Resources Limited (NYSE:TECK)

Source: Teck Resources Q1 2019 Financial Statement

As at March 31, 2019, Teck only had $1.162B in debt outstanding over the coming 5 years with none of it due for another 18 months. The company continued to de-risk its balance sheet announcing that it would redeem the June 2024 8.5% notes. This removes the highest cost debt from its balance sheet and leaves just $562m coming due prior to 2035. In the same press release, the company announced it would increase its share buyback by another $600m, or roughly 5% of its outstanding shares. On top of this, Teck received notice in February 2019 that it had regained its investment grade credit rating. This allowed them to replace letters of credit, which are claims on their cash, with normal guarantees, thereby increasing their financial flexibility.

With free cash flow of roughly $1.0B in the trailing twelve months, Teck is as stable and robust to downside risk as it has been in decades. I personally prefer them to utilize share buybacks in lieu of dividend increases as it gives them the discretion to take advantage of down trends in share prices while minimizing its cash commitment in the event of another downturn in pricing.

Teck’s major competitors for investors looking for exposure to these base commodities are Vale SA (VALE), BHP Group (BHP) and Rio Tinto (RIO). All have substantially larger market caps than Teck and are weighted more towards iron ore than coal. Both of these factors should weigh on Teck’s shares somewhat, especially due to the headline risk around coal with initiatives like the Paris Accord and the Green New Deal in the news. We can see that the pricing environment has been stronger for iron ore than coal. Iron ore has been ticking up since it bottomed in 2016:

ChartData by YCharts

We compare this to the coal chart. Coal has not sold off but has not been near as robust as iron ore:

Teck Resources' Balance Sheet Strength Gives It A Valuation Edge - Teck Resources Limited (NYSE:TECK)

Source: Company Presentation, RBC Conference, June 7, 2019

This provides a headwind for Teck compared to its more diversified competitors so this must be considered in any valuation gap.

If we look at the headline metrics for these companies (Market Cap, Revenue, EV to EbITDA, Debt to Equity, Total Debt), it would appear that considering its revenues and earnings, Teck trades at a substantial discount. Some of this is offset by the fact that it has a higher debt load compared to its equity valuation, though some of this will be driven because Teck trades at a discount.

ChartData by YCharts
ChartData by YCharts

If we continue to compare its cash flow to debt, Teck looks to be substantially less robust if we just focus on its Free Cash Flow compared to Debt. This misses the efforts it has made in structuring its debt; this shows in how robust its Times Interest Earned ratio is:

ChartData by YCharts

The Takeaway

I believe Teck offers a decent amount of safety, comparative to its large competitors. The company has termed out its debt very well, with a very low servicing cost, especially compared to cash flows that are somewhat muted over the last year due to stable pricing compared to rising prices enjoyed by its larger competitors. With the recent debt retirement, Teck has a lot of freedom to grow its business or to continue to buyback its shares with very low near term debt obligations. In the worst case, it will be able to survive an economic dip better than any previous time.

Technically, I wanted to pull back and look at Teck’s shares on a weekly basis:

Teck Resources' Balance Sheet Strength Gives It A Valuation Edge - Teck Resources Limited (NYSE:TECK)

Source: Finviz, weekly charts

Teck has bounced off of $18 several times, most recently in May 2019. There doesn’t appear to be much resistance until roughly $26, making it a decent risk reward here. Should it break below $18, I would consider this very bearish, but it has a lot of technical upside from here.

Teck’s robust capital structure gives it a lot of security to handle the next down turn while also the latitude to pursue its growth initiatives. I will continue to hold shares here.

Disclosure: I am/we are long TECK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.