Don Lindsay joined Teck Resources (TSX: TECK.A/TECK.B; NYSE: TCK) as president in January 2005 and became CEO in April 2005. The long-time mining executive spoke at the Bank of America Securities conference on global metals, mining and steel on May 12. His remarks touched on the impact of trade wars and COVID-19 on commodity prices and margins, Teck’s portfolio of assets, including its goal to increase its copper portfolio and reduce its coal business, as well as cost-cutting measures and the company’s growth strategy going forward. Lindsay concluded his speech noting that Teck had weathered share price declines in the past and would do so again. He also noted that compared to the last down cycle, the company is in a stronger financial position with a reduced debt profile, strong liquidity and secured funding for its massive QB2 (Quebrada Blanca Phase 2) copper project in Chile.
Don Lindsay: “When I spoke at this conference this time last year, we had just come off a year of record revenues, record EBITDA, and record profit attributable to shareholders and we had just announced first-quarter EBITDA of $1.4 billion. Our steelmaking coal operations had achieved an all-time quarterly production record in the fourth quarter and set an annual record for total material moved. Antamina achieved record annual combined copper and zinc concentrate production; we sanctioned our QB2 copper project; and we de-risked substantially. We entered into a partnership agreement that dramatically reduced our funding requirements for the project, and we secured a US$2.5 billion project financing that won an award, and it relieved us of any further funding requirement until mid-2021. And we’ve made very good progress on construction of QB2.
We regained our investment-grade credit rating, having significantly strengthened our balance sheet by reducing net debt by US$4 billion over the four years prior. And we returned more value to shareholders totalling $1.4 billion in the form of buybacks and dividends from 2018. We also launched Race21, our innovation-driven business transformation program that is targeting $1 billion in ongoing annualized EBIDTA gains at a very low capital cost. Finally, with the rising focus on ESG performance, Teck was and remains strongly positioned. We launched our updated sustainability strategy with ambitious targets, and we were named the top mining company globally on the Dow Jones Sustainability Index. We are also proudly an ICMM member company, and will be fully aligned with the enhanced ESG performance expectations recently launched by ICMM.
I think this look back provides meaningful context for assessing Teck’s future earnings potential, based on the innate strength of our company, and the quality of our assets, and not where the world sits today, with the global economy on its knees, and our key commodity prices at their lowest in years. The world is facing a time of unprecedented challenge, and COVID-19 is like nothing any of us have seen in our lifetime. We have implemented stringent measures across Teck sites, to keep our people safe and working, and to keep essential production moving. Where that wasn’t possible, such as the QB2 project, we temporarily suspended construction and are working to ensure that we can quickly resume once public health authorities say it is safe to do so.
Now those are things that we can control. What we can’t control is the impact on global commodity prices from global trade disputes, the oil price war, and the collapse in economic activity caused by the global pandemic. We can’t control these factors, but we certainly can quantify the impact. As most of you are likely aware, since Jan. 1 of last year, we have seen steel-making coal prices fall by 53%, zinc prices have fallen by 20%, copper has fallen by 12%, and Western Canada Select oil prices have fallen by 41%. So these price drops on their own are definitely significant, but when you do the math, you’ll see that the impact they’ve had on our margins is even more dramatic. In that same time frame, at spot prices, our coal margins have actually declined 93%, zinc margins are down 50%, copper margins are down 28% and energy has gone from positive per barrel contribution of about C$7, to a negative per barrel contribution of about $25, at current spot prices. And I think, as we all know, commodity prices and their effect on margins, are the single-biggest driver of share price.
The commodities that we produce have been hit particularly hard: coal, zinc, Western Canada Select and copper. But they’ve been really hit hard when compared to companies that produce the less affected commodities such as iron ore or gold. For example, iron ore is a significant outlier, having actually increased in price 22% since the start of last year, and gold is up 30%. I did some math and determined what the iron ore price would be if it had experienced the same as the metallurgical coal price, and had gone down 53% from where it was last year, and the iron ore price would not be $88 a tonne, it would be $33.90. And the gold price would not be $1,700 per oz., it would be in the $600s. I wonder what the gold [producer’s] share prices and the iron ore producers’ share prices would look like then.
We are simply not an iron ore producer, nor are we a gold producer, nor are we a copper-gold producer, so comparisons to those companies that produce those commodities simply don’t make sense. In the face of lower prices for our commodities, we have moved aggressively to reduce our operating costs to maintain margins of profitability where we can. What is important to keep in mind, is that these recent challenges, and the resulting price declines, do not in any way change the underlying strength of the assets of our business.
As of April 20, we had $5.8 billion of liquidity, including $525 million in cash, and we maintain a US$4 billion revolving credit facility, of which $3.75 billion is available. Importantly this facility is committed all the way out to Q4 of 2024, and it does not have any earnings or cash-flow based financial covenants. It does not include a credit rating trigger, and it does not include a general material adverse effect borrowing condition. The only financial covenant is a net debt to capitalization ratio that cannot exceed 60%, and, as of March 31, that ratio for Teck was only 20%. We have built a company that can weather this kind of downturn with long-life, low-cost assets that can generate strong returns through multiple commodity cycles.
In copper, we have a stable platform of production with Antamina, Highland Valley Copper and Carmen de Andacollo, and growth opportunities as far as the eye can see, starting with the QB2 project under construction now. Our copper growth strategy will see us rebalance our portfolio, and, as one of the lowest carbon producers of copper, we are well-positioned for the ongoing electrification and decarbonization of the economy.
In our steelmaking coal business, we are in the top half of the margin curve. Our mines have consistently delivered higher operating margins than many other major steel-making coal exporters. And we have more than 30 years of reserves and over 100 years of resources of high-quality steelmaking coal. Further, we are also amongst the lowest carbon intensity producers for steel-making coal in the world, positioning us well, as we are with copper, for the transition to a low carbon economy.
We also have a world-class zinc business. With our flagship Red Dog mine, one of the largest and highest-grade zinc producers in the world. It’s located firmly near the bottom of the industry cost curve, year after year.
We regularly evaluate the asset balance within our portfolio. Some people call this a strategic review. We believe its management’s and the board’s obligation or responsibility to continually look at our asset balance. And one of the assets that we’ve been clear about is our interest in the Fort Hills oilsands mine. Looking back, with the benefit of 20-20 hindsight, the fact is, we very likely would have made a different decision back in 2006 when we first entered the business.
But the world has changed quite significantly from then, in the last fourteen years, and at that time, though, we had quite a number of reasons why we thought it was appealing. At that time, peak oil was the theory, and oil was trading consistently above $100. Four of the ten largest market-value companies in Canada were oilsands companies. And it was also a mining business. We weren’t getting into the drill for and explore for oil business. It was large open-pit mining, shovel truck operations, and we had a lot of expertise in that. It had a very long reserve life of about 50 years, which meant that you’d be able to catch several economic cycles, probably five or six cycles during that time. It was also in a very stable geopolitical jurisdiction, and in the mining business, that’s becoming more and more rare.
And then for most of the last ten years, the oil industry tended to trade at a higher multiple of EBITDA, between eight and nine and possibly ten times, whereas the base metal companies tended to trade between five and six times, so in balancing our portfolio, we hoped that overall we would get a slightly higher multiple of EBITDA. Also note that it was also a pretty good hedge on the diesel consumption that we had structurally built into our company,
And the Fort Hills project itself was amongst the lowest carbon intensity oil production in the oilsands, and is lower than half the oil that is refined in all of the United States today. The project featured proven technology and a very experienced operator with Suncor, and, in fact, it had technology upside … which helped lower the carbon intensity per barrel of oil.
And then once the project was built, we were very impressed with the performance. Eighty percent of projects of this scope never actually hit design capacity. This one, within three weeks of the third train starting up, hit design capacity for a day or two, and by the end of the year, it operated in December 2018 at 104% of capacity that month, with an adjusted operating cost of C$23 per barrel. So it was a tremendous engineering and operating success. Unfortunately, then Alberta moved in with the shut-in program, and it has not been able to run at capacity since then.
But we have been very clear that if we can’t see the value of Fort Hills reflected in our share price, we will not hesitate to pursue other options for realizing value, including divestment at the appropriate time. And we have been saying this for over a year now. I should say that these are physical assets; it’s a lot easier said than done. It’s a lot easier probably to dispose of a share position in a company than it is to sell a physical asset.
So overall our operating margins have fallen dramatically over the last 12 months due to commodity price declines and the impact of that is clear. But the underlying strength and longevity of the world-class assets in our portfolio has not changed, and it represents significant upside potential once we emerge from this period. So that’s where we’ve been and where we are, the real question for investors of course is where do we go from here? Our approach is actually quite straightforward. Teck is implementing a copper growth strategy, financed by the strong cash flows from steel-making coal and zinc. We are focused on rebalancing our portfolio to ultimately make our copper portfolio larger than our coal business, beginning with the building of QB2, which will double our copper production on a consolidated basis, and we expect that growth to coincide with rising global demand for copper. The technology and infrastructure needed for a low carbon economy will require significant amounts of copper, from electric vehicles to clean power generation and transmission.
We are also seeing an increasing awareness of the role that copper’s antimicrobial properties can play in fighting transmission of infections like COVID-19. In fact, a news story from last week about the reopening of a Toyota factory in Canada noted that they are now using copper to coat handrails as part of their preventative measures to fight COVID-19, so we could see new demand growth for copper for health-related application such as creating infection resistant surfaces, and, in fact, Teck has sponsored the installation of copper … in intensive care units in several hospitals in Canada.
Our focus for steelmaking coal is not to increase volumes, but rather increase our margins, and our overall competitiveness. That business generates billions in free cash flow, providing capital for returns to shareholders and to fund our copper growth, and, as a result, and in contrast to many of our peers, Teck does not just aspire to growing its copper business at some point in the future, we are in execution right now, with a world class mine that is planned to be in production in 2022.
And as I’ve said, we can’t control the global economy, or pandemics, or commodity prices, but we can execute on the right strategy to ensure that we are well-positioned to generate shareholder value in the near term and the long-term. We are focused on four key value-creating capital priorities in support of our strategy.
First we are executing on QB2, a long-life, low-cost operation with an enormous ore body providing major expansion potential, which could put it among the five largest copper producers in the world in the second half of the 2020s. Second is investing in our Neptune terminal to optimize margins and optimize performance in our steel-making coal business by securing a long term, much lower cost reliable supply chain, and we’re on track to complete the upgrades at Neptune in the first quarter of 2021.
And in a similar vein, we’ve just completed the expansion of our Elkview plant. We’re very pleased to do that during COVID-19, and this replaces high-cost tonnes from Cardinal River with lower cost, higher-margin production. And at US$150 per tonne coal prices, that switch will add C$160 million in annualized EBITDA.
Third, we are driving towards a billion dollars in ongoing annualized EBITDA improvements for low, one-time capital costs through the Race21 business transformation initiative. And of that total, $500 million was originally targeted by the end of 2020 and another $500 million in 2021. Though COVID-19 may affect our timing, our teams are still focused on achieving those targeted EBITDA improvements.
And fourth, we are advancing our cost reduction program, to reduce costs across our business by a total of $1 billon dollars of previously planned spending to the end of 2020, of which we’ve achieved about $450 million to date since starting the program in the fourth quarter of 2019. And we are also continuing to review our cost reduction measures with an eye to identifying further savings.
What is most important to remember is that we are in an investment cycle. We are deploying the capital necessary to maximize the value of our steel-making coal business and to execute on our copper growth strategy, and we know that investors tend to be cautious during these phases, and they take a wait and see attitude. In fact, we’ve seen something very similar before, during the financing and construction of another high-altitude copper mine, and that was Antamina, which also coincided with a significant downturn in the market.
Teck’s share price was in the penalty box throughout that development period. But our then CEO and now chairman emeritus, Dr. Keevil — he had the vision and the tenacity to see it through, and, once completed, and once the market cycle turned, as it always does, Antamina was a crown jewel operation that has generated exceptional returns for close to two decades and still has many years to run.
The same will be true again, once Teck’s current investment cycle is completed, we will be transitioning to a period of significant free cash flow underpinning strong cash returns to shareholders. We are moving towards significantly reduced capex, lower costs, reduced execution risk, a better portfolio mix and increased cash flow, and we expect to see that reflected in our share price.
We are executing on these priorities to create value and position Teck for decades to come, including and especially in an environment of increasing focus on ESG factors, where our strong performance and leadership will earn a premium.
We have a very capable, highly engaged, battle-tested management team that is working hard to keep our people and communities safe, while continuing to execute on our strategic priorities. By contrast with the last down cycle, which ended in 2016, we are in a much stronger position with a reduced debt profile, strong liquidity and secured QB funding, and, most importantly, we are advancing a copper-gold strategy that is funded and being implemented, and we are confident that that strategy will drive significant value over the long term as the world recovers from COVID-19.”