Teck Resources Limited (TECKB) Earnings Call Transcript & Summary

Ladies and gentlemen, we're going to continue with our presentations. My name is Oscar Cabrera. I cover the cyclical commodities on the metals side for CIBC. I'm delighted to introduce our next guest, Teck Resources. We are delighted to welcome Mr. Donald Lindsay, President and CEO. Don, thank you for joining us.

Great to be here.

And we're going to jump right into question-and-answer period. If there's questions from the audience, please do interrupt me, and if there's a subject that you want to touch on. But Don, there's been a lot of uncertainty with trade wars over 2019. We have the coronavirus now. So as you go into 2020, what do you think the biggest opportunities and challenges are for Teck?

Okay. It's an interesting situation because we just kind of started to get through the major trade battles between the U.S. and China, which had been a source of risk-off behavior. Things on a supply and demand sort of fundamental basis were starting to build kind of nicely in copper and met coal and so on and then coronavirus hits, right? And that does affect things at the margin that if you have a lot of people that are isolated and not showing up for work in infrastructure projects that things will slow down. It will affect demand for commodities somewhat. But if you go back to 2003, the SARS incident, there was a really good article on Financial Times this morning that talks about what affect it had on markets. And in the end, it was really only about a 2 month, it was an intense 2 months. But by the end of the year, markets were up 30%. The markets affected most were Hong Kong and Shanghai. Hong Kong up 25%, Shanghai 30%. So the big question is, nobody knows yet about coronavirus and will it be better or worse than SARS. But if it tracks what happened last time, then we have somewhere between a 2- and 6-month period, while the world gets it under control that will affect the perception of -- maybe not the absolute demand, but the perception of demand for commodities. If it goes back to normal, then this is not going to present like a pretty interesting buying opportunity for a lot of people because we did see the world getting through and getting back to a more stable situation. In terms of challenges for Teck, we have 4 key priorities that we're working on that will make quite a difference in what I'd call the medium-term, which is 12 to 24 months. And I know markets are more quarter-to-quarter. But for us, we can't really manage quarter-to-quarter. So in order of priority, first is QB2. And obviously, this is a very large copper project. Ultimately, it will be one of the top 5 copper mines in the world. And it's a 100-year resource, and it has great expandability that it will double, on a consolidated basis, our copper production and ultimately, triple it. And that will rebalance the portfolio from what right now is overweight to coal, more coal than we would want. But we don't want to sell. It's a great business. One of the best mining business in the world. But to the extent that we can dilute the percentage that coal is of our revenue EBITDA by growing the copper business, getting copper to be equal in size and then ultimately, larger than coal. And then you add on the zinc and energy, then coal goes down into 30% or 35% kind of level. That's a better balanced portfolio. So we're all hands on deck on the execution of that. I know that there's concerns in the market that there might be a large CapEx overrun. We've announced that we will, at the end of March, disclose the definitive estimate. And we'll review that on April 1 with our Investor Day, which I know you always attend. And definitive estimate, what that means is that it's supposed to be that each part of the project is at least 25% complete. And so the number that we disclosed at least gives you some confidence because 98% or 99% of the engineering is done. Same like 97%, 98% of procurement is done. All the camps are in place. All the contractors are in place and mobilized. You have a track record of several months and weeks to weeks of percentage completion. And you get through issues such as social unrest. Social unrest in Chile, it obviously, has been a big issue, right? And it definitely caused delays for us, and it may affect cost. And the kind of delays that we saw, were in the early days when it was quite intense. You had a lot of people who didn't show up for work. You could have, on some days, as many as 30% people don't show up. Well, clearly that hits productivity, which hits schedule, which hits cost. So you can expect that when we announce our definitive estimate, we'll announce a revision to schedule of some sort. But remember, we did have contingency in the schedule. So that helps. We also had issues where moving oversized equipment from the port to the mine, you normally need a police escort. Needless to say, there were no police available in that time because they were all dealing with social unrest. So that caused delays. So if you have a 600 tonne crane that comes in different pieces that you need there, it took several weeks till that got there. Now it's there. Now it's behind us. Archeological issues, where human remains are found in the desert, someone who died 100 years ago. Historically, people didn't pay attention to that. Now that's roped off and you can't have access to the site or build the road that was going to go there until it's all gone through and there was only one archeologist that the government had, and they had to hire another one, so on. So we ran through all those things, but now we're kind of through all that. And things starting to look like they're progressing more according to plan. So anyway, we'll be able to give all the details on that. QB2, for us, when it's finished and starting up in 2022, at $3 copper, that's $900 million of EBITDA to Teck, right? And if you look at our sort of run rate at normal commodity prices, that's almost 25%. That's important. And the rebalancing, which hopefully helps the multiple. Priority #2 is RACE21. RACE21 is our transformation, innovation and technology program. And it is so exciting to see some of the things that are happening right now, and I could go on for hours, but we committed to showing $150 million increase in EBITDA by December 31 just passed. We will announce the results of that on February 20 with our results. And I am now confident that it has happened. We need to prove it to you all. And so we will list all the different projects and the before and after on what we've done. But the reason why I'm so excited is because that means that for the rest of it now -- between now and the end of 2021, that, that $150 million is going to go up to something in the order of magnitude as the same as QB2. The only difference is it's like 1/10 the capital and happens in 2 years, not 10 years. So it's extraordinarily impactful. Everybody in the company is excited about it. But we have to prove it to you. And so that's coming, and it will come. First, $150 million and then larger and then significant in the second year. The third one is finishing Neptune expansion. Neptune expansion, of course, has a big overrun of CapEx, and I want to explain the details behind that and why we're doing it and why it is so economic and structurally positions the company for the long term. So we had a lot of trouble with Westshore. They changed their business model and started taking a lot of thermal coal and often putting that in priority to our coal because they had a 10-year contract with us, and they would choose to ship our coal when they liked, which often wasn't when prices were high. In one quarter alone, in 2018, they cost us 1 million tonnes of sales when margins were over $200 a tonne. That's over $200 million of EBITDA in one quarter alone just because they didn't give us the service that we wanted. So you look at numbers like that, we could spend almost anything on Neptune, where we control it, we don't have to port. It's only our coal, and we're able to deliver it when prices are high. But worse than that, they were contaminating our coal with thermal coal. We had like dozens and dozens and dozens of incidences, including one incident where it was so severe that our largest customer stopped sending ships to them, right? So this is something that in modern day and age you need to deliver quality product. We have high-quality, hard coking coal. And so at Neptune, will be -- there won't be any thermal coal there. So we won't be contaminating it. So it solves that problem. And then last, but not least, they charge a lot. And you can deduce what they charge by looking at their financial statements, but order of magnitude is triple what the Australians pay, whereas when we go to Neptune, we'll be more in line with the Australians. So the economics are very, very powerful. We're not happy that the CapEx doubled. Here's why. We were faced with this situation with Westshore. We had to get away from a company that used monopolistic pricing practices and so on. And there was a deadline in that we had a permit that was going to expire, and we had a contract that was going to expire on March 31, 2021. So if we wanted to switch from Westshore, we had to have it built by that date. Now the permit is for an inter-harbor port, and those are not that easy to get. Certainly, nobody in the West Coast in the U.S. was going to get one. We had one. If it expired, we went back to get it, who knows if we would have gotten it. We did have a pre-feasibility study finished, but very low level of detailed engineering done. And so the Board later on made a decision that we got to get that built at the very least to have negotiating leverage, but it may be that, that's the route we're going to go for the long term. Well, as it turns out, that is the route we're going to go for the long term. So we started building it with the pre-feasibility study, which we then determined, once we were into it, had left off significant items of scope that needed to be out of back end, and we weren't happy with the contractor that we had, and we fired them. We brought in Fleur. They redid it. The number is $800 million. It's now gone through past the definitive estimate level that I just talked about with QB, and so our level of confidence in that is quite high, and there's 12 months to go. So as each month goes by, the risk is getting behind us. And the key risk items from an engineering point of view, some of the things were underwater -- below sea level. That's now complete. And so that gives me a lot more confidence. So I can't wait till a year from now. And as it starts to ramp up and that will put us in a position for the long term, while costs will be significantly lower. So that was the third priority. The fourth one was CRP, our cost reduction program. When the coal price hit $130 there for a while, I didn't want to wait and see whether it was going to last or not. It's come back to $152 today, but -- and remember, every dollar is 30 million tonnes of EBITDA to us, so it makes a difference. But anyway, we launched a CRP program. One thing, our team is really good at is cost reduction programs because we had that 5 years to practice, right, with a long downturn, and we did 3 of them then. And we were known for that. We're successful. So it was fascinating to see my Senior VP of Coal here, Robin Sheremeta, like -- he was like, well, this I can do, right? We could get right into it. And so we set a target for $500 million, and we'll disclose the results of that on February 20 as well. But suffice it to say that we're going to do better than that. And so when you put all that together, coal price going down, the CRP program, the effects of RACE21, the company 6 to 12 months from now is going to be a lot stronger than now. Now we are going to have 2 really tough quarters. And part of it is deliberate because we moved the Elkview shutdown into the first half. And so that means we will be producing less and you have a lot of fixed costs. So that means fewer tonnes to spread the fixed cost over. So our costs, even though Q4, you'll see we set targets for that, I can't tell you what they were, but we're happy, and you could be very pleased with that. But in Q1, they will jump way up again because the costs go down while we shut down Elkview. And so we'll recover part of it in Q2. But Q3, Q4, we'll be at that new base where we have 2 million tonnes of high-revenue, low-cost coal from Elkview that replaces 1.4 million tonnes of low revenue per tonne, high cost. When I say costs, I'm talking about $65 a tonne versus $110. That's why we're placing it. So the strength of the business in the second half of the year is something that we're working towards. And as I say, we can't manage quarter-to-quarter. We have to build the company for the medium and long term, make it stronger. And it looks very good from that point of view. So those are the 4 things again. QB2, RACE21, Neptune finished and CRP.

Yes. If we can just jump into capital allocation. Within that context, during last year, you were pretty explicit in how you're seeing the different buckets and how much you can return to shareholders. Do you -- going into 2020, with all these things that you discussed, do you think that there's room, as QB2 expenditures start to rise, to keep the same pace or a lower pace of returning cash to shareholders?

Well, really, the answer to that really depends on commodity prices that you assume. So certainly, if commodity prices had stayed where they were in May, there would have been room. And remember, in May, we increased the buyback from $400 million to $1 billion. So that was larger than the 30% that's at the end of the model. We have a capital allocation chart in our IR presentation that shows you where it goes, and it's a commitment that at the end after the base dividend that 30% of what's left goes to either buybacks or dividends. That's just a minimum, could be more. And by the way, while I've been CEO, the average has been 38% through it all that time, even though we didn't have an IR slide that said so. So it's pretty consistent. At $130 coal, the answer would be no. At $150 coal, we'll see, depending -- copper has come down a lot in the last -- coronavirus has hit it down to $2.59. In those circumstances, I would say no. But you're getting more or significantly more than the 30% this year. So we'll see. But this is the big CapEx year, 2020, with QB2. And then it tails off in 2021. So -- and then after that because then everything is finished then, right? Neptune's finished, QB2 finished, the SRF is finished. All those things. So that's kind of pure cash flow at that stage. So I would say, at those time, you're going to see more than 30%, right?

I mean, we were discussing this last night that ESG has become an important factor in the overlay from institutional investors in general. So you guys are at the forefront of it being recognized about it, but why you consider it to be the main issues? And should -- what do you think that the market needs to understand so that we can all move forward and not limit your ability to continue to grow in certain parts of the business?

Right. So I feel a bit more comfortable today than I did 3 months ago on the ESG issue. But there's no question, ESG and the intensity of it from the institutional investor point of view has ramped up a lot in the last 6 to 12 months. 6 to -- really, the last 6 months has been quite intense. And so we're in what I call an educational phase. So we have carbon, no question about it. We have coal, and we have oil but the distinction is, we have the good coal, not the bad coal. I talked to Larry Fink last week and the BlackRock has made their announcements, but it's about thermal coal. We have 99% high-quality, hard coking coal, steelmaking coal. We only have 1% thermal coal. And so that institution is one of our top 5 shareholders, and they still are. And they won't be selling. I was with Christiana Figueres, the women who saved the world, who chaired COP 21, and she introduced me on a panel. And she said, now Don's company produces the good coal, not the thermal coal. Now she still went after me on other issues, but my point is that you can't educate people and they start to get it. And certainly, our top 20 shareholders all totally understand it. So it's incumbent upon us to keep educating people. I'd love to change the name of steelmaking coal to something else, so that people could understand that it's entirely different. But the one thing is for sure, the world absolutely needs 2 commodities: steel and copper, right? And infrastructure can't be built with all aluminum or something. It's got to be steel. And the population of the world is going from 7 billion to 9 billion. You can't stop it. Mostly in developing countries. They don't have scrap to use electric arc furnaces for it. They will have to use blast furnaces. There's lots of talk, lots of rhetoric about hydrogen, and there's a pilot plant being built. But the reality is, to get the reduction required chemically, it takes twice as much energy in a hydrogen process than it does with coal. So that means you've got to have clean energy or your emissions are even worse. My customers, meaning Nippon and POSCO, so they tell me, it's at least 20 years away. Meanwhile, like the world because they're hesitant about thermal coal, is not going to be investing a lot of new capacity, but the populations are growing, still, still, still growing. So if the average price for coal the last 10 years, or even longer 11, almost 12 years, is $180, my guess the next 10 years that it's going to be that or better. It's going to be up and down as all the commodities are. But why did our debt come down so fast it's because we collected $100 -- $180 and had all that cash. And I think we're going to get that again.

Yes. So staying with coal. In iron ore during the year because of the issues or the accident in Brumadinho, there was a shift towards lower quality coals because higher quality was too expensive. Have you seen the same in metallurgical coal? I think, it's been the reverse as prices just has been flat. But in the middle of last year, we saw a drop to $130 that you alluded to. What are you seeing? Like what are your clients doing? And do they still -- do you still have a clear visibility on what they're asking you to deliver?

Yes. So there's 2 different questions or 2 different issues in your question. On the drop in coal prices, that was triggered as much by Trump's tweets and trade wars and risk-off behavior as it had to do with demand of specific qualities of coal. Like, I think they're 2 different issues. The iron ore producers, I mean, Rio and BHP, Anglo to a certain extent, I mean, really are only -- they benefited from Brumadinho, a horrible tragedy, right? Iron ore went up $30 and they're collecting the cash, good for them. Sometimes, we benefit when we get a cyclone in Australia, right? No fault of ours, but we benefit. And they're still benefiting, though. I think that will level out at some point. But in both iron ore and steelmaking coal, quality is here to stay and blast furnaces steel companies differentiating for both productivity reasons and environmental reasons that the higher quality, which we have, will get better margins going forward. It will vary from here or there. But in general, that will be true.

Right. And the issue that the Canadian Federal Government raised on selenium and calcite, has that been -- have there been further discussions? Any updates that you can give?

We don't have an update. We don't know ourselves, but the process continues. It's going to take many months. I don't have a date as to when we'd be able to say anything on that.

Okay. And then just getting back to China environmental restrictions, that limit supply. Is there a price or -- an incentive price for coal where you would consider developing Quintette and the MacKenzie Redcap?

Yes, that's interesting. So last year -- a year ago last week, the CEO of one of India's largest steel companies tracked me down and he wanted to -- he himself, his company wanted to buy 4 million tonnes of coal. Now just to give you context how big that number is -- 4 million tonnes per year, right? And he wanted it by the end of this year. How big that number is, to all of China, we'll sell less than 3 million tonnes this year. We now sell more to India already than we do to China. That's how much things have changed. So like to the extent that people used to think of us as a China-only story, like, we have derisked the China part of it. Now we could have done that with Quintette, and he was even willing to give us financing to open Quintette. But we looked at the whole thing, and you've heard the expression value over volume. And you've heard me say before that expression keeping, Oscar, you've heard me say for years that you always make more money in this business on price than volume. And we were enjoying prices $200 plus on 27 million tonnes. And always remember when BHP and Rio went valley, and they fought to see who was the biggest in iron ore, and as soon as they get one expansion finished, they do the other one, right? And they put that market into surplus and took the iron ore price from $120, $140 down to $40, right? And I just thought, like, I've got this really good business. We're making tonnes of cash flow. Do I need that extra 4 million tonnes? Even though this guy wants it, I'd rather keep the market tight. At some point, our competitors in the U.S. shutdown, there's an opening. If you can ring-fence it and say, okay, we'll open Quintette, 4 million tonnes will go to these 4 customers only in India, the market will never see it. Yes, then we'd do it. But we're trying to increase the proportion of copper and rebalance their portfolio away from coal to the extent that the people are hesitant about carbon. So we thought it was better not to do it, and the same kind of principles apply to the Cardinal River. But some day -- I mean, an entrepreneur would buy Cardinal River from us and we're leaving the plant there. And like that's a valuable asset you could start up. But I'd rather keep the proportion in our portfolio lower, even though it's a great business. I mean, it's one of the best mining business in the world. The cash flow. I mean, you know what? Here's some numbers. Analysts don't publish in this way. But our coal business, in the last 4 years, had $13.5 billion of EBITDA and $8 billion of free cash flow, like cash after all [indiscernible] right, $8 billion. And the market value of our whole company is just a little bit above that. That's the last 4 years. It's got a 100-years resource. And people -- when you look at the analysts and say, any of these lot of people have like $5 billion or $6 billion out of their 401. I mean, it's an extraordinary business.

Right. It is. But if we move to copper, your partnership with Sumitomo is quite unique in the industry. I think it's a great way of derisking a project without diluting shareholders. So as you evolve and look forward after QB2, there's other projects in your portfolio, but your build-versus-buy decision, is it changed completely from a couple of years ago before QB2? Or you still consider there's some projects out there that could compete with the returns that you're getting out of QB?

I don't think there are projects out there that can compete with QB2. Because remember, the structure -- there's the returns on the project, first, on an unlevered basis. Then there's the project finance going in, which is -- one deal of the year. You saw that it’s a fantastic deal. And because by choosing Sumitomo as a partner, they brought JBEC with them, which is very, very attractive financing. EDC, the Germans and the Koreans, the state agencies. This is very attractive. So you put that in, then you put the equity that Sumitomo puts in on our behalf. So next thing you know, we're in this 30% to 40% IRR range at $3 copper and [ 10 above ]. So there's not much out there that gets that kind of IRR, right? Well, there's nothing. So that's why we should do nothing but execute QB2 as well as we can. And the other is QB3 beyond that. And yes, we'll finish the coke we started, but I think I should stop talking about that because everybody knows we've got a 100-year resource. I should just demonstrate to the market that QB2 is going to be fine, right? And just this laser-like focus on that and nothing but that. We'll finish Neptune up, we'll finish pretty soon, but that's sort of be our priority. And we don't have any need for like acquisitions. We have 5 other copper projects. We're going to sell one probably pretty soon. And that'd be more capital to buy back stock, if you want, but we haven't done yet, but it's a good project. We got a lot of interest in it. So like, we're rich in asset. We're rich in resources. When I started, we were challenged in resources, right? High Valley was going to be shut down in 2018 and -- in 2008, I mean. And we would -- the only copper we would have had was Antamina. And by doing the different things that we've done, we actually have -- if you add it up, we actually have 8 copper projects. Not that capital is going anywhere that way. But between QB2 under construction, QB3 in scoping study, Zafranal just finished feasibility study, San Nicolás in finishing prefeasibility study, Mesaba, Schaft Creek, Galore Creek and NuevaUnión. So we're pretty lucky with the pipeline. We don't need to do anything.

Yes. That's clear. I just want to make sure that if there's questions in the audience, please? No. Otherwise, we're going to like zinc and oil sands. But on zinc, what are your thoughts currently after the price has broke down quite a bit market? There was more supply into the market, but now this is melting bottleneck.

So as with equity markets, commodity markets are often driven by sentiment, and sentiment can overwhelm fundamentals for quite a long time. And I think that's what we're seeing in zinc. The zinc inventory in the LME this morning is 50,150 tonnes. This is extremely tight, right? And people think there's hidden inventories out there, but we had a backwardation that was very extreme and it didn't draw the hidden inventories in. Why was that? Probably because they're not there. But people perceive because the commodity consultants say that there's surplus will concentrate, which is real, is now going to be turned into refined metal by the smelting industry in China coming back on. And I guess treatment charges are higher and environmental restrictions have kind of been applied. I have an office in Shanghai and the people there, this is their job. They're smarter than that. They tell me, yes, some of it's going to come on, but not nearly as much as what the commodity consultants say. And just before coronavirus hit, people were starting, oh yes, zinc cut down to $1, and then it started to creep up to $1.11 again. It got hit the last 2 weeks with coronavirus, but that was starting to realize. You know what, there's not as much zinc around as people thought and the smelting industry is not coming back as fast. Now we'll see how it plays out. Coronavirus is going to affect things for a while. But I think the market is tighter than people believe.

All right. Don, last, but not least, on energy. Fort Hills completed successfully. Any -- do you have -- do you think that, that part of the business needs to grow because we talked about base metals being almost half of the EBITDA?

Yes. So I mean in the end, the energy division isn't that material a part of our story really. And I would want to make sure that people don't get too focused on it. Fort Hills, from an engineering and operating point of view, has been a tremendous success. As 80% of projects that l scope never hit design capacity, right? Fort Hills hit design capacity in the third week that the third train opened for a few days, that was in May, and then by December, it ran for a whole month at 104% of capacity and a cash cost of CAD 23, and that's before the debottlenecking that Suncor knows it can do. It can add another 20,000 barrels a day with almost like very little capital and then moderate capital. So they can take it up to 240,000 barrels a day and cash costs around $20. That will be fantastic when it happens. But what's the situation today? Alberta has got the cap on. It can only run at 150,000 something, and that drives costs up to $29. And so that gets the double whammy on your financial results. You don't have the pipelines, so the differentials are high. And so we have to -- we just have to work our way through these next 2 years till it gets done. But it has the potential at reasonable commodity prices to be $900 million a year of EBITDA, it'd be our third-best asset -- second- or third-best asset. So we have to wait and see. In the meantime, I tell you, recently you've seen a drop in oil price with coronavirus effect there, too. And so there'll be a bit of a squeeze for a few months, we'll see. But generally, it doesn't affect us too much while we wait. And Frontier is anyone's guest on what the federal government is going to do. So we'll see about that.

Excellent. We started getting questions on -- like, is that the next project after QB2? But I think you have been pretty clear.

No, we've been very clear that we -- there was very little capital being devoted to get the permit. So it was worth getting the permit. And we've done all the things. We -- some pretty high hurdles were set by the federal government, and we've cleared them all, and we have 14 out of 14 indigenous groups sign support agreements. And remember, it's not dirty oil. This oil, the carbon emissions are half the industry average in North America per barrel, half, right? So this would actually displace dirty oil. But anyway, we'll see what the cabinet does. And we've told the government that for it to be developed, we need 3Ps. The first is the pipeline, has to be finished, not just started, finished. We need a partner. We need price. So we'll just wait to see how that unfolds.

Great. Well, with that, sir, thank you very much. Ladies and gentlemen, could you help me thank Don for his presentation? Thank you, sir.

Great, thank you.