Teck Cominco (TCK – ADR): 03/28/2007

Current Price: @ $70.79

Teck Cominco is a diversified mining company based out of Canada. And when I say diversified, I mean diversified; the business is separated into 4 segments: base metals, coal, gold and refining/smelting. The base metals is by far their largest segment, comprising 66 – 72% of revenues in 2005 and 2006. Their base metals segment comprises of zinc, copper, lead, molybdenum, indium, germanium. Furthermore, their future internal growth prospects include oil sands, nickel, diamonds, ocean floor mining, zinc oxide, etc. with an eye toward including more non-exchange commodities for less volatility.

Upside:

• 2^nd largest zinc producer in the world.
• Diversified mining segments theoretically means less exposure to volatile commodity markets.
• Majority of assets in politically stable regions.
• Research shows relatively few “community” issues in regards to their mines (relative to their size – almost all mining companies have “community” issues)
• Highest dividend yield in the mining sector (> 2% currently).
• Crazy free cash generator. Their balance sheet cash is crazy – over $20 per share.
• Appear to be undervalued – book value is under 3x (~$27/share) + cash (~$20/share). This doesn’t include their gold properties which have yet to really translate to bottom line figures nor their growth prospects.
• Patient, value-focused management – failed Inco takeover was disappointing but the fact that they didn’t get into a bidding war and overpay bodes well for stewardship of investor money
• Extremely low debt that has been structured so that half is not due until 2011 and the other half not due til 2030. In any case, cash on hand (over CA$5 billion) more than covers all long-term debt (CA$1 billion) today much less years from now.
• Good pipeline of future production projects in various stages of development.
• Joel Greenblatt Magic Formula Investing screen pick – extremely high return on capital and earnings yield.
• Attractive possible future revenue streams in oil sands, diamonds, seaboard mining and zinc oxide.

Dangers

• Uncertainty regarding where the business cycle is right now. Traditionally commodities and mining is cyclical and right about now would be the time to rotate out of this sector. However, the liquidity glut has really distorted the economic cycle, making it hard to rely on the past to point to future moves.
• Coal prices have already softened (including the hard-coking, metallurgical coal that they produce); zinc and copper have had historic run-ups. Maintaining near-term earnings growth will be difficult, much less growing them.
• Possible (likely?) U.S. recession could lead to global slowdown and less demand for commodities. In any case, U.S. copper demand is already down due to the housing bust.

Management:

• Integrity: B. Don Lindsay, CEO: I appreciate their approach to managing the company – very Buffett-esque. They won’t overpay for acquisitions and stress patience in waiting for opportunities. In the meantime, they are buying back shares to return value to shareholders while allowing for future flexibility to raise capital if needed. Obviously focused on creating and adding value for the company. However, there were some hints of defensiveness and evasiveness during the Q4 2006 conference call so I’ll be cautious on this.
• Past Performance: A: Their results the last few years have been outstanding. Free cash flow has been positive the last five years, growth has been good, etc. Things look as if they might be slowing down now as a few mines ramp down or go into transitional phases but a good pipeline of projects should position them well down the line.

The Reasoning:

The intangible economy seems to be on its last legs and with the growth of the emerging markets, we should see a strong demand for raw materials. Combine that with forecasted massive infrastructure investment and the fact that the solution to many of our looming crises will require tangible technological solutions like machines, equipment, etc. all made out of stuff.

So why Teck Cominco? Simple: This is a great company run by stellar management with a long-term vision. They are probably undervalued with many of their assets (like gold) and growth prospects seemingly discarded from their market valuation. In addition, their mix of segments is attractive. Copper and molybdenum may carry the business one year, metallurgical coal the next, perhaps oil sands 3 or 4 years from now and so forth. I like how their oil sands plays right into their area of expertise (mining) as contrasted with BHP Biliton, which behaves much like a traditional oil company in its oil/gas operations.

This is definitely a long term play but we’ll get paid a little dividend while we wait and it’s already cheap at a P/E around 7 (the Earnings Yield is even cheaper). The company shouldn’t be in too much danger in a market correction or economic slowdown and any severe dips should be obliged as buying opportunities.

I won’t be surprised if it finishes down for 2007. Since I can’t time the market, I won’t mind this possible volatility as I expect good things in the years following.