I want to open this piece by talking about when I first drafted it. I started this July 27th the day both Don Lindsay’s retirement and the passing of Lukas Lundin were announced. It’s hard not get a little sentimental and reflective thinking about the passing of the torch to a new generation in this industry given both of those events.
Giving into those sentimental and reflective thoughts, I attempted to take on the challenge of a comprehensive piece on Teck that then snowballed into a bigger picture commentary on the industry. It was total mayhem and chaos, even the koala couldn’t follow it all.
I want to talk about Teck and the future for the company and its portfolio for the next 10-15 years and the opportunity in front of Mr. Price as the new CEO, but reality is there is one big decision to be made first. We can pick up the rest of the story another time.
What to do about Fort Hills/Energy?
The Eucalyptus TLDR: Keep it and tell the fast money hedge funds who speak of an ESG multiple re-rate and a sum of the parts unlock to get a catalyst for their next bonus cycle to forget about it. If the portfolio in its current form is good enough for NBIM, then it’s plenty ESG
My feelings on Don have been very love / hate but like I said on Twitter during the conference call, he really has grown on me in the last few years starting with the deal to bring Sumitomo and the project finance into QB2 to dramatically reduce the cost of capital and the financial risk of the build.
Don deserves more praise than he gets, but I think that’s a function of his time he served in the seat. The last couple years of the China supercycle pre-GFC, the rebound, followed by what I tend to think of as a decade long death march through purgatory and re-framing of the mining industry. While the bottom was January 20, 2016 for the equity share prices, I don’t think as an emotional/sentiment bottom we collectively bottomed until March 2020. Glencore traded below its September 2015 equity placement price for crying out loud.
In light of that industry/market environment, that Don went forward on QB2 in 2018/19 knowing most of the buyside hated the capex, the return profile, etc. took bravery and conviction. Sure the dual share class structure probably helped steel those convictions but he dutifully did the roadshow rounds and took his thrashing like a professional including from the koala.
Which is why one of my favorite secondhand Don Lindsay stories of recent years was at the last BMO conference a portfolio manager had a 1x1 meeting and apparently started just criticizing Don, his track record, his capital allocation, everything. And the story goes Don very calmly gave four fundamental responses to the criticism (imagine it was Cash Flow from Ops / share v peers, and a few other classics) and then, Don got up and walked out of the meeting. Let IR do the meeting, he wasn’t going to sit there and take that crap with coking coal on fire and QB2 on track. He was done explaining himself and apologizing for his multiple when it wasn’t his fault no one understood the strategic need for steelmaking coal beyond 2030!
We are going to come back to that later, but let this be branded into the branch of the eucalyptus tree you are staring at – “I am done apologizing for something that is not my fault”. This is a new frame of mind in the mining industry in the 2020s and frankly I relish it.
And that is going to matter for Teck now that we come to Jonathan Price, a rockstar in his time at BHP. In many ways, his success as Chief Transformation Officer led to him being speculated as the CEO to come after Mike Henry. And before I say the next point, I like Mike Henry a lot, seems like a good guy. But we all know when a CEO succession occurs, the first people who go in the restructure of the senior leadership team are:
1) The runner up in the succession race (if internal)
2) The CEO in waiting – just in case the board gets buyer’s remorse early on
This is a roundabout way of saying, Teck has really lucked into a world class pseudo-external candidate who has been in house as the CFO for approximately 2 years to absorb the culture and ready to step up into this role.
And as with all CEO transitions, there will be changes. Price was asked on the 2Q22 earnings call if he had any top of mind strategy changes/modifications and he dutifully said he was happy with strategy as is. But like Jakob at Rio Tinto bringing forward decarbonizing PacAl, there will be changes once Price has been in the seat 12-24 months and set his course. After all, what is he going to do with all that coking coal free cash flow and copper free cash flow with QB2 running at full production?
But before we get to that point, Price has one major strategic decision to make in the next 12months that will set the tone for this tenure.
What to do about Fort Hills/Energy?
The recommendation from the koala: Keep it
A CEO sets a culture and tone but really makes 5-10 impactful decisions every year and they better get those right a lot more often than they get them wrong. And strategically this is first big one for Jonathan Price.
Teck does not need the money to delever its balance sheet or fund stock buybacks now or in the short to medium term. The next big greenfield project is 3-4 years away and the balance sheet can fund that.
If you sell Fort Hills at 2-3x EBITDA to buy back stock at 3x EBITDA, have you really created any value? It’s an oversimplified question but one worth thinking about.
So don’t get sucked into the sum-of-the-parts (SOTP) and ESG multiple story – you’d be selling or spinning oil sands at a depressed multiple that would not create incremental value for shareholders. It is better to take the free cash flow from oil sands and use it to fund the attractive pipeline of growth projects Teck has in base metals or the buybacks that are ongoing.
But investors think there is this magical group of funds for whom divesting oil sands will make Teck a buyable security. Let’s take a look at that using a real life example – NBIM, the Norwegian Sovereign Wealth Fund.
Teck is not on the NBIM exclusion list like Freeport (Grasberg environmental) or Glencore (coal production) or Peabody (coal…) or Whitehaven (take one guess…)
But you know who I don’t see on the list – Arch Resources, Alpha Metallurgical, or Warrior Met Coal
And BHP is under “observation”
https://www.nbim.no/en/the-fund/responsible-investment/exclusion-of-companies/
So one clear triangulation from this is the Norwegian Sovereign Wealth Fund differentiates between met coal and thermal coal.
Now as for oil sands they do have CNQ, Suncor, and Imperial all on the exclusion list for being oil sands companies.
So what would losing the Norwegian Sovereign Wealth Fund as an investor mean for Teck Resources if a small minority interest in Fort Hills was simply not acceptable at all?
Per the 2021 Annual Report, the Fund owned <1% of the shares of Teck. Put another way, if the Fort Hills exposure became an issue even though Mt. Arthur is not an issue for BHP, Teck could call Oslo and say “we’re keeping Fort Hills, if that is a dealbreaker for NBIM let us know and we will buy you out using our buyback at the lower of 5 day VWAP and last close”
Teck could afford to do that without blinking.
But that aside, it is not secret Teck has a minority interest in an oil sands operation and is a major Steelmaking Coal producer.
And NBIM owns Teck today!
And despite the existence of Mt. Arthur within BHP as a small fraction of the portfolio/business, BHP is not on the exclusion list either for producing thermal coal!
In fact, given the events of the last twelve months, the only potential reason the koala would seriously entertain selling Fort Hills is because a major chunk of the shareholder register has said “either it goes or we go”. But candidly, so what? If it is good enough for the Norwegians it’s probably good enough for everyone.
For that reason, I don’t see the pool of incremental investors that will view Teck as investable just because oil sands is gone. The ESG investor crowd that goes beyond the bar of NBIM are puritanical zealots.
If Teck walks away from oil sands, the ESG puritans will not stop there. Oil sands will not be enough of a sacrifice for those funds that have built their businesses and AUM off of virtue signaling.
If an investor cannot tolerate a <10% EBITDA contribution from oil sands, there is absolutely no way it will accept a 30%, 20% or even 10% EBITDA interest from Steelmaking Coal.
For all the talk about “I can’t own Glencore because of coal and it’s limiting of the investor base” it is quite laughable to see it become the consensus long among London diversified mining names basically all year so far.
So Jonathan, a piece of advice from the koala, don’t feed the ESG puritans and their sum-of-the-parts (SOTP) hedge fund allies, keep oil sands.
You may give them a pop on the news but will you actually bring in new investors?
The koala does not believe so, but does thing there is an array of fast money multi-manager/pod hedge funds that dream of being long Teck the day a Fort Hills divestiture is announced so they can sell a 10% pop. Ironically, I think people will be shocked to see that hypothetical pop will not stick as there will not be buying on the other side of the multi-managers turning over their book to unwind their Teck/whatever pair.
So with the incremental investor point set to the side…what’s better than being the only diversified mining company that is not short petroleum product pricing as we are in an energy crisis?
Teck in its 2Q22 calls spoke about operating costs up 14% versus comparable 2Q21 with half of that increase due to diesel prices being up 75%. Must be nice to have had a C$200MM EBITDA swing in the Energy business as a partial offset to that.
Fort Hills provides a real hedge for the overall portfolio on energy costs and the capital is sunk already. Teck does not need the money for its balance sheet or to buyback stock given its free cash flow generation.
Let’s look at what is happening to costs in the mining industry right now given energy prices levels.
Escondida, the world’s largest copper mine, has been guided by BHP to grow production 10%+ over the next twelve months but will have higher $/lb cash costs as well due to fuel prices and inflation. Think about what that means in a massive open pit mine to have higher unit costs with 10%+ volume growth due to higher grades.
That suggests the costs to run Escondida next twelve months are up ~15-20% year on year. That isn’t all fuel/energy but a funny thing about commodity supercycles – costs don’t typically go down or stay flat during them.
Go look at the copper cost curve in 2002 versus 2011…if you believe in this supercycle you should welcome having an embedded portfolio hedge. And part of those costs are energy and fuel.
We have seen this is the cash cost guidance increases for multiple open pit mines in the recent reporting cycle, insert “it’s happening” gif here.
I know it’s hard to let go the sins of the past, and building Fort Hills was a stupid idea in hindsight, but it’s the last new major oil sands asset we will see for probably the next 10+ years when you consider permitting (Teck dropped Frontier permit application in Feb 2020 remember) and construction timelines.
This is a strategic asset in the world we are in today that you could not recreate today even if you had all the money in the world (see permitting / ESG). Though the koala wouldn’t mind a little more takeaway capacity to get better realized pricing.
Now some will pushback on this view and say “BHP just divested Petroleum”, but BHP did not have long life very low decline rate assets. BHP by their own admission had a very clear choice to make – invest or divest. Teck in oil sands does not have to make that same decision, because oil sands is more like a mining operation then a conventional/unconventional oil well. The decline rate is effectively zero. Fort Hills will not require major capex for a very long time.
Jonathan Price should, like his predecessor, lean on the dual share class structure (as terrible governance as it may be) to allow yourself to look through the fast money investors demanding a sugar high catalyst to generate their bonus for the current cycle and the ESG purists.
After all, just because Teck doesn’t own its stake in Fort Hills or its current interest in the Steelmaking Coal business doesn’t mean the barrels and tonnes won’t be produced.
It would be one thing for an institutional investor to say “expand steelmaking coal or Fort Hills and we divest” and quite another to say “sell to someone who probably won’t operate nearly as well as you do or we divest”. The former is a rational argument to make if deeply ESG oriented while the other ignores the reality that those tonnes and corresponding emissions will still be produced under a different owner. Glencore has driven this point home about its coal business and I’ve noticed it is starting to get some traction.
When you have broker analysts asking if you’d consider temporarily increasing coal volumes because the world is desperate for incremental energy units like one did on the recent Glencore results call, you know something has changed in the prevailing sentiment.
So, if Teck can reduce shares outstanding by 5-10% consistently every year and show that any growth capex (or M&A) is accretive to FCF / share, and do it for 3 years, the investors of the world will give Mr. Price the benefit of the doubt even if there is a small oil sands position in the portfolio.
In fact, this is a critical point about the industry at the mega cap/large cap level. Management teams are starting to realize they can’t control when or why the market/investors will return them to the multiples they had a decade ago. All management teams can do is execute and dutifully allocate capital well. The whims of investors are fickle but a track record of consistent value creation has a wonderful way of helping investor get over whatever it was that was bothering them 1-2 years ago or even 1-2 quarters ago.
And if you are going to be buying back stock for the next several years to prove out a capital allocation track record with a bolt on M&A or greenfield capex here and there with a very conservative balance sheet, wouldn’t you rather be buying back stock at 3-4x EBITDA instead of 5-6x?
Think a certain billionaire made that observation in his annual letter once upon a time.
And that buyback train for the next few years is what Teck will be on because Don has left Johnathan Price the ship at the inflection point – QB2 deliverance is imminent and the cash flow profile will flip into being a gusher.
Can someone say the word compounder about a diversified mining house? Think we might be able to later this decade as these large caps keep executing and allocating capital well.
Sure Suncor after sorting things out with Elliot could offer a deal in shares at a very attractive valuation, then Teck should consider it. But there is no point selling at a depressed multiple.
But koala, the free cash flow of the entire portfolio can only buyback so much stock, what else should Jonathan Price do with the free cash flow?
Well, that is for another piece later on because if there is one thing Teck has, similar to Vale Base Metals, that stands out versus the other diversified mining houses is a robust pipeline of organic base metal growth properties that in this supercycle will be very attractive.
There are opportunities galore to create value for shareholders. It’s just a question of where to start. And we will pick that up another time in the eucalyptus tree.
Nice post. The argument for Fort Hills to be an opex inflation hedge is very convincing to me.
Excellent point. I invested in Teck for the reason you mentioned; they have an energy hedge against inflation.
Looking forward to your next piece.