Teck Cominco - Q3 2007 update

This report lays out some of the reasons I (dis)like and have (not/sold) bought this stock. It does not constitute personalized financial advice. Please do your own due diligence or hire a financial adviser, if you're so inclined before making any investment decisions.

Report by Davy Bui

EPS came in @ C$1.15, down from C$1.17 YOY with the strong C$ being fingered as the main culprit. Adjusted for the FX move, EPS was C$1.27 from C$1.17.
Cash flow from operations (OCF) increased 8.2% to C$814M YOY while FCF increased 5.1% to C$676M. 2007 YTD OCF is far less rosy with OCF down 33% to C$1.2B and FCF down 49% to C$751B. The main culprit is the big jump in working capital due to increased royalties and taxes related to Red Dog.
The company has been drawing down cash with the Aur Resources acquisition, Novagold partnership and increased Fort Hills oil sands stake.
Overall, realized commodity prices were flat YOY, with big jumps in lead prices offsetting weakness in the coal market.

Here were the performance measurements laid out in my last update:

lower costs @ Pogo & Hemlo
update on Morelos
hit production target @ Lennard Shelf
rein in operating costs
hit Red Dog production numbers
consolidate Aur Resources numbers
improve operating cash flow results

Teck's flat financial results don't bother me much as the company does not control commodity prices or currency exchange rates. But the company does have control over their operations and from this standpoint, they really missed the mark.

Once again, Teck managed to mine gold at a loss. Hemlo cash costs decreased slightly from $612 to $600/oz but this was more than offset by Pogo's jump from $460 to $554/oz. Pogo's gold production came in below capacity and lower than the previous 3 months. Hemlo is undergoing strategic review and also produced less gold than the previous quarter.

TCK did manage to resolve the community blockage issue at Morelos and are pondering several mine plans that would produce roughly 250,000 oz of gold annually at a cost of US$248-$283/oz. The mine is expected to last 9-11 years.

Annual production targets at the Lennard Shelf zinc deposit will be missed as the company hit a double whammy of lower production and higher unit operating costs. The company broke even in Q3 and now projects 2007 production of zinc between 40K - 45K tonnes.

Operating costs, excluding depreciation & amortization, jumped 38% YOY and 30% from last quater. This increase fast outpaces revenue increases of 18% YOY and 24% sequentially, thus leading to compressed margins up and down the income statement.

The company's jewel Red Dog asset maintained zinc volumes while increasing lead volumes but even here, there was trouble as the US EPA has withdrawn a renewed water discharge permit due to community opposition. Management stated that this was not a case of increased toxicity but rather of procedure. The company doesn't anticipate any risks to Red Dog production. Needless to say, any impairment at Red Dog will be very troublesome.

Aur Resources results did not factor into this quarters numbers.

Operating cash flow improved markedly over the previous 2 quarters but it looks likely the company will fall short of last year's C$2.9B OCF. At 9 months YTD, we are sitting at C$1.2B OCF.

This is the third straight quarterly report I've used the word "disappointing" to describe Teck Cominco's performance. I had previously valued TCK at US$50 per share and from a value standpoint, holding this stock still makes sense for my portfolio -- especially as the current share price reflects a sizable amount of currency depreciation. But the company's dual shareholder-structure, poor operating abilities (at least for this year) and limited prospects in context of industry consolidation (due to the company's relatively small size and dual class share structure) makes it unlikely to attract a takeover bid. My outlook for base metals is still favorable and I'm tentatively planning on holding my shares at least through the 1-year holding period for favorable tax treatment, at which point I'll evaluate the company's place in the investment portfolio.

DISCLOSURE: Please see our portfolio page for all disclosures

The Enlightened American

Teck Cominco - Q3 2007 update