FCX - The Teck Resources Saga Continues: Deciphering The Company's Next Move

2023-10-26 18:01:35 ET

Summary

• Teck Resources Limited reported Q3 earnings and faced a selloff due to higher cost estimates for its QB2 copper project in Chile.
• Glencore is still in the race to acquire Teck's coal business and has reserved cash for potential M&A.
• Nippon Steel is reported to want to buy a 10% stake in Teck's coal business for C$1.15 billion, valuing the overall business at about C$11.5 billion.

Teck Resources Limited ( TECK ) recently reported Q3 earnings , and it sold off pretty hard. The primary reason was likely higher cost estimates for its major QB2 copper project in Chile. There was still no announcement concerning an in-the-works sale (I wrote about this back in May ) of its metallurgical coal business. Teck initially proposed a complex plan to spin off its coal assets. That plan meant it would basically enjoy the revenue for another few years, but not officially own the assets. Meanwhile, Glencore plc ( GLCNF ) stated it would take over the coal problems for $8.5 billion.

As recently as August , Glencore still considered itself in the race and it has actually been reserving cash:

We still got our second tranche of the announced $5.6 billion cash amount at the beginning of the year. That's $0.22 that we paid in September. The final $0.2 billion of the $1.5 billion buyback that was announced was completed in July.

We've got $1.3 billion of announced transactions, which we expect to close in this half, and Gary will speak to some of those later on. That leaves $4.2 billion, what we effectively reserved or allowed for, put a placeholder around potential M&A and clearly putting a name on it. There is the particular Teck situation, where we announced that we put in an offer cash for Teck's coal business back in June. That itself, if it were to consummate, would be a material cash-funded acquisition.

And as part of appropriately rethinking the business and steering it towards its eventual outcomes, we've set itself if that transaction was to materialize, we would look to then spin off that larger coal business as soon as possible. Once the business has reached its target leverage levels expected to be within 12 and 24 months, and the non-coal business would be brought down to a leverage level of no more than $5 billion. So this is an attempt to start thinking about finding the right balance between shareholder returns today and rewarding shareholders and positioning for potential outcomes.

Now of course, if nothing eventuates from that particular situation, that $2 billion immediately comes back to shareholders or as soon as practical. Now of course, we can wait until February. We can do out-of-cycle potential increases to buybacks or the like, but that's not going away. It's in the business, and it's been reserved for a particular situation. We thought that was an appropriate balance as we build back up towards the $10 billion or putting down $2 billion and just limiting the peak of what balance sheet net debt may be at a particular point in time, where we historically said we wouldn't go to more than $10 billion to $16 billion as well to facilitate M&A and then de-lever appropriately as well.

Teck ultimately scrapped the vote on its separation plan under pressure of shareholders. I don't think Teck management loved that, but it forced it to engage more seriously with Glencore. But, over time, there have been many names mentioned ( here and here), including Freeport-McMoRan Inc ( FCX )., Anglo-American ( AAUKF ), Vale ( VALE ), JFE Steel part of JFE Holdings ( JFEEF ), JSW Steel, and Sumitomo Metal Mining ( SMFG ). Sumitomo originally said it supported Teck Resources, and it is a big owner (~18% of the A-shares). There aren't a lot of A-shares compared to B-shares. However, the A-shares come with 100x voting rights.

Nippon Steel ( NISTF ) is reported to want to buy a 10% stake in Teck's coal business for C$1.15 billion, valuing the overall business at about C$11.5 billion ($8.3 billion), with an option of increasing its stake to 17.5%.

I was specifically interested in the TECK call because I wanted an update on this process. I wasn't the only one. The company provided a rehearsed update but also answered several analyst questions regarding the separation process. I'll go over all the relevant comments (emphasis by me):

Thanks, Crystal. Before I wrap up, I want to provide an update on separation. With responsible value creation as our North Star, we continue to engage with a number of parties that have expressed interest in our steelmaking coal business. We're evaluating a range of potential options guided by several objectives. Based on extensive shareholder feedback throughout this process, one of our core objectives is to achieve a full separation of our base metals and steelmaking coal businesses...

First of all, there seem to be multiple bidders in the race. That's a positive. Second, I got the impression management was preparing shareholders for a solution where it is not selling to the highest bidder. The excuse being to avoid further friction with regard to the sale. That's fine with me if the friction is serious and real (not merely perceived), and (emphasis added):

An i mportant consideration will be the certainty of achieving separation, including receipt of the required regulatory approvals. And it is also critical that the transaction allows us to maintain social and environmental commitments to stakeholders in the Elk Valley. Overall, the Board and Special Committee are pleased with the progress we have been making. Separation remains a priority, and we are moving through the process as expeditiously as possible.

I don't understand why the company wants to avoid a sale to Glencore. However, Glencore's advances lead to politicians grandstanding , and perhaps that's enough cover to go with another deal. I don't see how Glencore's dollars are worse than Sumitomo's, but perhaps we'll have a credible explanation soon (emphasis added):

We have a competitive process, which is the most important thing here to ensure we have options ahead of us to realize a good outcome. As I've mentioned a couple of times recently, I believe we'll be in a position to make a decision before the end of the year. That hasn't changed. The key thing for us is to ensure we make the best decision here possible rather than rush the process. But as I said, we're well positioned right now.

The CEO is talking about "a decision" instead of a "negotiation" or "process" or something which implies all the final bids are in. The timeline is consistent with earlier remarks. I think it is a positive that the end of the year remains a soft deadline (emphasis added)"

So I think the view of the market has changed long term. Whilst the spot price is very encouraging, right now we look through that and we look to the long term assumptions here that underpin the business.

I think as well, post the discussions we had earlier in the year regarding separation, the appreciation for EVR as a long life, high margin producer of very high quality hard coking coal has increased in the market as well. So look, I think there has been a move in expectations over the last six or eight months as a result of those two factors. And of course, in discussions with our shareholders, which have been ongoing throughout that period, they convey to us their expectations here as well. And that's something, of course, we take on board as we think through the options in front of us.

CEO Price laid out how much the steelmaking coal market had improved since earlier in the year. He also pointed out that the market understanding of the value and longevity of metallurgical coal had improved. I'm optimistic this indicates a higher implied valuation than $8.5 billion for the coal segment (emphasis added):

I mean, I think, we've discussed the range of options that we have before us here with a full sale at one end of the spectrum and a partial sale and a spin at the other end of the spectrum with the latter providing ongoing exposure to our shareholders in respect of both the steelmaking coal market, the fundamentals of which look very attractive going forward, and of course, a quality high margin business like EVR.

Unfortunately, he also seems to be floating the idea of another spinoff here. Something very important the CEO said is that the company is looking for a clean break and any transaction needs to be comprehensive. It would be really bad were it to sell its coal on the cheap while Teck is still left with a little bit of coal interest and still won't be able to claim to be a battery-metal or future-oriented metals producer.

Conclusion

From this earnings call, I get the sense Teck Resources Limited is quite likely to announce a separation before year-end. It is a guessing game whether they sell the coal business to Sumitomo, Glencore, or another party or propose something convoluted again.

Gun to my head; I'm thinking they are leaning towards a spin-off with a large cornerstone investor who sets the pre-spin valuation at ~$10 billion. That could be Nippon Steel, JFE Steel. Perhaps Sumitomo would roll over its stake into the new company but give up the super-voting under some circumstances.

Meanwhile, Glencore or another party may have put something with a higher number on the table, but that will be deemed the less desirable option for some reason.

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