2023-06-19 05:56:51 ET
Summary
- Teck Resources has scrapped a vote on spinning off its metallurgical coal business after receiving a takeover offer from Glencore.
- I believe that selling the coal business for cash is preferable, as coal, in my opinion, is a dying industry and its value will inevitably decline.
- A sale of the coal business would leave Teck as a pure-play metals company with a strong focus on copper, offering upside potential for the stock.
Teck Resources Limited ( TECK ) recently scrapped a vote on its plans to spin off its metallurgical coal business following an unsolicited takeover offer from Glencore plc ( GLCNF ) ( GLNCY ).
Glencore has since submitted an all-cash offer for the coal business. At the moment, metallurgical coal may account for a larger part of Teck's profits but the copper-focused metals unit is certainly the more interesting division going forward. Overall electrification inevitably requires large amounts of copper. Use cases range from EVs to electric stoves to only give a few examples. What's more, global production grows only slowly. McKinsey sees an annual production gap of up to 6.5 million metric tons by 2031 based on current supply projections.
Below, I will explain why I believe that a separation of the coal division via an all-cash transaction would be preferable and where I estimate the value of the remaining company after a sale.
Coal Sale Would Be The Right Move
Coal, in my opinion, is a dying business in the long run. Hence, I believe the value of any coal business will inevitably decline. I do not expect that metallurgical coal will be used for a period remotely as long as the 30+ years of predicted reserve life . My expectation would be, that aforementioned decline would be sudden rather than linear, with the turning point being the moment when hydrogen-based steel production gains the cost advantage in addition to being less environmentally problematic. While it is certainly not easy to predict a concrete year, I have little doubt that this moment will come. Carbon taxes and measures of the same effect (such as the EU's carbon permit system) make coal artificially more expensive, while subsidies will drive down the cost of hydrogen. Add to that the ESG requirements are increasingly forced upon producers by the financial markets.
Consequently, from Teck's point of view, the earlier the coal business is sold the better. Especially given that steel is a very cyclical business, and a prolonged recession now may significantly reduce the value of metallurgical coal reserves due to total demand before the cutoff point decreasing.
The spin-off structure initially envisioned by Teck would only superficially distance the company from legacy coal operations as it would still be deriving significant cash flows from the commodity. Markets, I assume, would still take this form of exposure into consideration when valuing the company. From my point of view, a straightforward, all-cash sale is clearly a favorable solution.
The general concept of separation is supported by chairman emeritus Norman B. Keevil, Jr. and Sumitomo Metal Mining KK (STMNF) (SMMYY). Through Temagami Mining Co., Mr. Keevil and Sumitomo Metal Mining control a majority of 55 percent of Teck's Class A shares which come with hundred voting rights per share. The Class A shares exclusively trade at the TSX (TECK.A.CA), whereas the Class B shares are also listed on the NYSE. Sumitomo Metal Mining additionally owns about 19 percent of the company directly, the overwhelming majority of which is through Class A shares. Of course, any such transaction would require a majority among Class B shareholders as well. But I think that approval would be likely.
In terms of a possible valuation, the cash valuation of around $8.2 billion implied by the modified first Glencore offer is probably a good starting point. After all, it is proof of interest to acquire the business at that price point. I would be rather surprised if Glencore's offer for only the coal division would be materially below the aforementioned threshold. Arch Resources, Inc. (ARCH) trades at 3.4 times forward earnings. Being a pure-play producer of metallurgical coal, the company may arguably be the best yardstick to measure Teck's coal business against. Based on that, $8.2 billion appears to be a reasonably attractive offer.
Metallurgical coal is not thermal coal. Synergies are limited, as use cases and by extension the respective customer bases are vastly different. Also, for the time being, the stigma attached to thermal coal (and the accompanying ESG implications) are arguably greater compared to metallurgical coal. However, with an all-cash transaction, all this does not matter from the perspective of Teck shareholders. Rather, these considerations will be left to Glencore and its owners to deal with.
Metals Business Valuation
A sale would, of course, mean that cashflows from the coal business are no longer available for the remaining pure-play metals unit. Hence, it would have to be valued on a standalone basis. I will base my calculations on the assumption of a cash consideration of about $8.2 for the coal business.
The number one copper producer, Codelco de Chile, is not publicly traded, but is owned by the Republic of Chile. Listed peers include Antofagasta plc (ANFGF), First Quantum Minerals Ltd. (FQVLF), Freeport-McMoRan Inc. (FCX), and Southern Copper Corp. (SCCO). Teck's production costs are relatively lower compared to all of the aforementioned competitors with the exception of Southern Copper according to Wood Mackenzie estimates quoted by the company itself.
Based on its net debt of CA$5.34 billion (presently around $4 billion) as of March 31st , a post coal sale Teck would have net cash of around $4 billion (prior to any direct distributions to shareholders). This assumes that the sold business would be identical with the Elk Valley Resources unit proposed by Teck's prior plans, thus being transferred without existing debt. That would give it arguably the strongest balance sheet within its listed peer group.
I believe that the Antofagasta of today may be a good yardstick to value a future standalone Teck metals division after an all-cash sale of the coal business. Currently, Antofagasta forecasts an annual copper production of up to 710 metric tons (which is the higher end of the span). Teck's lower-end forecast, on the other hand, predicts 390 metric tons in 2023 production. At the same time, with new Chile operations, the annual production will eventually reach, what Antofagasta is producing at present in terms of output, but at a lower cost basis. After a sale of the coal business, Teck would presumably have a stronger balance sheet, too. That should at least make up - if not outweigh - the differences between the companies' respective non-copper products (gold and molybdenum, respectively).
Antofagasta's enterprise value is slightly above $20 billion (around $886 million of which consists of net debt). An absolute enterprise value in the same vicinity would not at all be unreasonable, I think. Depending on what portion of the cash proceeds would be distributed to shareholders directly and over which time frame, that would translate to a market capitalization between $20 and $24 billion. To pin down a share price is more complicated, as direct distribution of funds may be done through buybacks, thus reducing the number of outstanding shares (on an undiluted basis prior to distributions of proceeds it would be up to around $46.6 per share).
Margin Of Safety
The first Glencore offer valued Teck at an overall price of around $22.5 billion. And Glencore reiterated its interest to acquire the metals business as well. Hence, there should be a certain margin of safety not too far off a market capitalization of said $22.5 billion (translating to an undiluted share price of around $43.6). Currently, the market capitalization is a little below this threshold.
Post Split M&A
The remaining metals group could still be a takeover target, be it for Glencore (who explicitly reaffirmed their continued interest in the metals business) or another player. So far, Freeport-McMoRan, Anglo American plc (AAUKF), and Vale approached, according to sources quoted by The Globe and Mail. This level of interest hints at the possibility of a significant takeover premium being achievable.
One obstacle may be the company's largest shareholder, who has effective veto powers. Norman B. Keevil, Jr. expressed his resolve not to sell Teck to Glencore at any price in an interview with Canadian newspaper The Globe and Mail, stating that it "Canada is not for sale". This leads me to believe that patriotic feelings - which at the end of the day are irrational - may factor into any decision. Notably, Mr. Keevil, in his memoir , writes of the "protection of our [Teck's] dual share structure" preventing the company from being "lost to foreign hands". Such sentiment, obviously, is not ideal as it limits the pool of acquirers significantly. On the other hand, the Keevil family has a strong partnership with Sumitomo, who is not exactly Canadian. So, at least as far as the coal business is concerned, I think decisions will be made reasonably. I would be less sure with regard to the remaining metals business. On the positive side, the company issued a statement somewhat watering down his prior comments, quoting Mr. Keevil's support for "a transaction […] with the right partner at the right time".
On the other hand, Teck would also be in a strong position to pursue inorganic growth itself via acquisitions, given a full war chest. However, the impact of such measures in terms of shareholder value would, of course, have to be assessed on the basis of specific terms.
Conclusion
Teck becoming a pure-play metals company with a strong focus on copper certainly offers some upside potential, especially if done via an all-cash sale of coal activities. Without the coal business dragging down multiples, the stock would be positioned considerably better to benefit from future copper demand and corresponding price increases.
The current share price is only about 11 percent off from where I would currently estimate the company's fair value activities - around $46.6 per share on an undiluted basis - under the assumption of a sale of the coal business for around $8.2 billion. At the same time, major shareholders' unwillingness to engage with Glencore could block a sale. Therefore, for the time being, I see the company as a hold. It could, however, become a buy, once copper prices increase meaningfully or/and if a bidding war for the metals business were to become a realistic possibility.
For further details see:
Teck Resources: An All-Cash Sale Of The Coal Unit Would Be Preferable