Teck Cominco Limited: All Copper, All the Time

| About: Teck Resources (TECK)

With nearly CA$5 billion burning a hole in their pocket at year-end 2006, it seems Teck Cominco Limited (TCK) CEO Don Lindsay and crew have been looking hard for places to put the money to work. Apparently, all paths were lined with copper.

The first major announcement heralded a joint venture with NovaGold (NYSEMKT:NG) to develop the Galore Creek copper/silver/gold project. Teck will make a US$478 million buy-in on the project which is expected to cost $2 billion. Lindsay noted the majority of Teck-controlled projects started as joint enterprises so we'll see where this goes.

The second deal was the $3.8 billion cash+stock friendly buyout of Aur Resources (AUR) at a 29% premium to market price. Once again, this acquisition is heavy on the copper. Up to 22 million shares will be issued to allow Aur stakeholders to maintain exposure. A 40 million share buyback program is still ongoing so the dilutive aspect should be minor (5-7% at most). No debt will be issued for this deal, which is projected to be immediately accretive and will boost copper production over 40% annually as well increase copper reserves over 140%.

Here are some items of possible concern to us stemming from these transactions:

  • Increased exposure to copper
  • Aur Resources offer appears fully valued in today's market
  • Galore Creek includes significant gold, which Teck mined at a loss in Q1 2007
  • The heavy copper focus suggests that perhaps the Antamina and/or Highland Valley sites may be slowing down. The company had announced that production at Antamina was coming into a lower-grade zone. They're also extending the Highland Valley mine which will cut copper production for the next few years. As copper is a third of their revenues and an even higher percentage of operating profits, maybe they wanted to shore up their copper production with these deals.

    Or perhaps management is extremely bullish on copper. On the latest analyst rounds, they've stopped talking zinc and have been putting forth the case that the copper market today, with Chindia, resembles the 1960-1980 period when Japan went through its growth phase. During that time, copper traded well above its 20-year average price ($2.25 vs $1.38 in 2006 dollars). Lindsay suggests a Chinese-influenced trading range of $2.50-$3.50 in today's market and said Teck is very comfortable with that range. Also, today's new projects and discoveries are lower-grade than in past times so pickings are getting slim. I can't imagine that Teck didn't run the numbers on Aur and Galore Creek using that range so they must feel pretty good about it, even at a 29% premium in current market conditions.

    As for the gold side, management remains as elusive as ever. They've put out the possibility of selling their gold assets or spinning them off to take advantage of the high multiple awarded to gold miners. However, they've stated that no decision will be made until the Pogo and Hemlo mines are brought to 100% operating capacity. At this point, the company's not focused on efficiency but rather just getting production up to speed. I'm sure it'll be discussed at the quarter-end conference call and, hopefully, we'll get something more definitive.

    These concerns aside, we remain confident in our investment. We'd like to see management move closer toward adding non-exchange-traded commodities to their portfolio, and Lindsay addressed this during the conference call: you make the deals that are available. As investors struggling to find attractive prospects in today's stock markets, we empathize with his position! Or to paraphrase a thankfully-departed bureaucrat, you go with the deal you have, not the deal you wish you had. Teck are moving forward with their exciting oil sand projects but we won't see first phase production until 2011 and other prospects like nickel or uranium haven't yet made sense.

    In summary, nothing here alters our assessment of the company. The portfolio composition hasn't changed much except to include more copper. The dual class stock still weighs on valuation though Lindsay mentioned the controlling family would be open to dropping that structure if circumstances arise. We await further word on the fate of the gold assets and how TC plan to extract value from them. And there are still plenty of "experts" warning of a sharp downturn in commodities any day now. In the meantime, we retain our trust in management and will add to our position on any significant pullback.

    Disclosure: Author has a long position in TCK

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