Selling Teck Cominco - I've Lost Confidence in Management

I sold our position in Teck Cominco earlier today (02/25/2008) @ $37.50 per US ADR. We made a marginal gain on this position (6%) and it's possible with the ramp up in inflationary trends that TCK may ride the wave along with other commodity plays. But to put it simply, I was wrong in my thesis and want off this ride. It appears I overrated management in my initial assessment of the company. Perhaps I should have paid more attention to the evasiveness and defensive tone I noted originally.

The company's financial results lagged far behind 2006 results, with income and cash flow off markedly. While it is not fair to hold the company accountable for currency effects and price drops (most notably in zinc), it is more than fair to hold management to account for the myriad problems with TCK's operations and project pipeline.

One of my original premises was that the diversified nature of their operations would help buffer commodity price swings. This failed to come off this year for several reasons: inability to realize value in gold assets, the "stranded" nature of their metallurgical coal assets such that even current run-ups in coal prices won't boost earnings until Q3 2008, failure to close any deals for new asset platforms, distant timeline on oil sands combined with government issues. The end result being that Teck Cominco heavily tracked (or trailed as other copper miners, say FCX or PCU, seemed to hold up better) the prices of copper and zinc.

Also, at time of entry, TCK had over C$5B of cash on the balance sheet. Now, that cash position is whittled down to ~$1.4B and it's hard to say that management has achieved their stated goal of diversifying into non-exchange traded commodities. They've added 3 copper mines and a troubled Galore Creek project. The Galore Creek re-evaluation casts serious doubts on management's abilities and due diligence. Less than 4 months after supposed due diligence on Galore Creek, they have to go back to the drawing board and write down $50M? From my view in the cheap seats, this looks really sloppy and reflects poorly on Don Lindsay's team.

Teck has also had operational issues all year at Antamina, their gold mines and Elk Valley. They've announced writedowns on the carrying value of the Pend Oreille and Lennard Shelf zinc mines as well as a write-off of their Tajera Diamond investment.

During last year's Q4 conference call, management testily defended their project pipeline, mentioning the following projects: Fort Hills & Lease 14/22 oil sands, Pogo/Morelos gold, Highland Valley extension, Santa Fe/Carrapateena, Tejera/Nautilus/Zinc Ox, Petaquilla copper/gold. With the exception of Highland, it is a stretch to say that any notable progress has been made toward realizing value on these projects. The oil sands probably face extensive capital costs if current industry trends are any indication.

I've discussed Teck's loss-making abilities mining gold in previous posts. Tejera is in bankruptcy protection. And the Petaquilla project is on a do-or-die timeline for the end of March as to whether Teck will proceed with their buy-in on the project. The capital costs for Petaquilla are prohibitive ($3.5B) and management gave every indication that this will be hard call on their end.

While the stock may still be cheap, part of my investment strategy emphasizes strong management whom I feel will deliver strong results and/or quickly recover if there is a stumble. At this point, Teck Cominco no longer fits in my portfolio. The portfolio page will be updated to reflect our divestment at the end of this month (Feb 2008).

Comments

[SA Editor J...:]

Davy,

Nice article and analysis. That being said, it doesn't seem you feel there is much downside risk here. TCK continues to trade at somewhat of a discount to its peers. Furthermore, analyst estimates appear to be fairly conservative for at least the rest of 2008 (seekingalpha.com/artic...). Despite selling, would you still say the risk/reward is in TCK's favor, even with management's bungling?

2008 Feb 26 09:23 AM

[User 156156:]

Good for you....for every seller there is a buyer. And now the stock is up a buck (1.00). Every market shakes out weak hands.
Maybe you should read the latest indicating that Teck will make more money on Coal and Copper. One should as the question did anything change? Did China and India stop consuming. Are other developing nations going down or up in their consumption? Well...

2008 Feb 26 10:55 AM

[TA:]

I've been waiting for $28 but the management mistakes you outline, it's a tough buy. I love those endless commodity consumption arguments, they make for funny reading...

2008 Feb 26 03:58 PM

[Davy V. Bui:]

Jonathan: My completely subjective, non-scientific opinion would be that downside risk is probably low (though not low enough for my standards). I guess the risk:reward ratio is positive but not extremely favorable. Long-term, I'm skeptical management can build exceptional long-term value in their oil sands or gold assets. Galore Creek was a blow and now Petaquilla looks ominous. Red Dog is a world-class asset but even there, they face increasing royalties and questions abound about a possible water permit problem, with a remote chance that further development may have to be shelved. The company also has a dual-class shareholder structure along with a relatively small $17B market cap which makes TCK a likely buyer of smaller companies rather than getting a premium from one of the big boys.

All that said, I had made a mental note to sell at $40. But once I reviewed last quarter's results, I sold out. In the end, TCK is heavily exposed to copper & zinc so you're basically riding the commodities price but with a capped upside while adding operational downside risk. In my mind, there are probably better companies to leverage the metals or else, consider an index like RJZ.

Blah: @$28, downside would be pretty limited -- I almost doubled down when TCK hit $27 a month ago but doubts about management stopped me. I guess that would have been a winner but I try to view it more like a poker game: just because the money card hit on the river doesn't make it a good bet!

2008 Feb 26 08:55 PM

[theskyiscrape:]

Blah123: All the easy metal has already been mined, and if metal prices do not increase to offset increased costs of extraction, then no new supplies will be mined. Unless of course a company wants to operate at a loss. You'd be a good candidate for this kind of company, SOMEONE WHO DOES NOT THINK MUCH PRIOR TO SPEAKING OR ACTING. India and China house about 40% of the world's population, and are growing rapidly. DO THE MATH. Why do you think companies like Nautilus are having a go for metals under the ocean, for recreation. An expensive form of recreation. Easy sources of metals are forever gone. Try informing yourself before leaving ignorant comments in the future. Thanks.

2008 Feb 27 02:02 AM

[Blenderboy:]

Tough trade at today's price of $42.00. A rising tide lifts all boats and with copper, coal, and oil sand assets this company's future looks good in today's commodity price environment. If nothing else it offers a hedge against a rapidly declining greenback.

2008 Feb 28 04:46 PM

[User 158491:]

What what what was I saying......Hummm. Let me retell nothing has changed. Also with all this inflation it is time to be in things. Sorry you felt this way about the stock maybe you should buy back in with all these upgrades.

2008 Feb 28 08:01 PM

[User 158491:]

Blah123.....you need to read some newsletters or books because I think your education is weak. Hey start out this Jim Rogers books and move on from there. Like you indicated, " love those endless commodity consumption arguments, they make for funny reading..."
funny all the way to the bank my friend.

2008 Feb 28 08:05 PM

[telemachus:]

Davy, Davy, Davy,
I think you sold too soon. Teck just reported a massive copper deposit as part of the Chilean properties that it picked up from the purchase of Aur Resources. This is a serious copper find and it will show up soon in the earnings in the near term.
More info at www.financialpost.com/...
Because of this news, Investors have already bidded up this stock to $41.50 as of March 3. The stock will probably earn $4 or more EPS for 2008, meaning that it will probably finish 2008 at $40 or more.

2008 Mar 05 01:22 AM