Why Investors Should Avoid Teck Resources Ltd. in 2015

Despite analyst upgrades, the jury is still out on whether Teck Resources Ltd. (TSX:TCK.B)(NYSE:TCK) is a potential investment opportunity.

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Last year wasn’t the best for Teck Resources Ltd. (TSX:TCK.B)(NYSE:TCK), with plummeting commodity prices seeing its shares routed plunging by 47% in value over that period. But with its shares now bouncing around their lowest point in over five years it has caught the attention of bargain hunters and analysts alike, with investment bank UBS recently upgrading it to a buy.

However, I believe this to be premature and recommend investors avoid Teck Resources throughout 2015.

Let me explain why.

First, the global commodity super cycle has come to an end.

The emergence of China as an economic superpower as it set out to modernise its economy and infrastructure over a decade ago saw its demand for raw materials grow voraciously. As a result, the years between 2000 and 2010 were particularly fortuitous for commodities miners, especially those producing metallurgical coal, copper, zinc and iron ore, with those commodities being key materials used in China’s ever growing construction and manufacturing sectors.

The surging demand for commodities pushed prices ever higher resulting in burgeoning investment in commodities particularly metallurgical coal, iron ore, and base metals. But this in the end only fattened global commodities production and inventories at a time when China’s demand for raw materials had started to taper off.

This over-supply coupled with declining demand from China and the European Union was the death knell for the commodities super cycle. The end result is significantly lower commodities prices. Metallurgical coal, which generates a third of Teck’s revenue, plunged to its lowest price in over five years. Copper and zinc prices also remain depressed for those reasons, and as they make up the remainder of Teck’s revenue, it doesn’t bode well its bottom line.

But the bad news doesn’t stop there.

China’s increasing focus on moving from an expansionary, export-oriented industrial economy to one focused on domestic consumption will see demand for metallurgical coal, copper and zinc among other commodities continue to decline. When coupled with growing global macro-economic instability and the likelihood of the Eurozone falling into another recession, the long-term outlook for commodities prices is increasingly pessimistic.

Secondly, Teck lacks the scale to compete with major global commodities miners.

In order to effectively mitigate the risks posed by declining demand, the world’s largest commodities miner BHP Billiton Ltd. continues to expand production. This includes growing metallurgical coal production, despite record low prices, as a means of creating greater cost synergies. It is also pushing prices down in order to secure greater market share by driving higher cost producers out of business.

This is a significant threat for Teck, because BHP’s metallurgical coal operations have significantly greater scale allowing it to drive better cost efficiencies. It plans to drive down costs to under AUD$90 per tonne in 2015. This would make its metallurgical coal more competitive than Teck’s, which for the third quarter 2014 reported costs of $91 per tonne, and even more so with the Australian dollar being weaker than the loonie. BHP also has far deeper pockets, giving it the ability to weather any major downturn in metallurgical coal prices for a prolonged period.

Finally, the much vaunted Fort Hills oil sands project is shaping up as a red herring for Teck.

The company has repeatedly talked up the prospects of this project, in which it holds a 20% interest, with partners Total SA and Suncor Energy Inc. But with the price of Brent crude plunging to under $60 per barrel, the economics of the project look increasingly shaky.

According to Andre Goffart, president of Total’s Canadian division, the partners require a Brent price of $100 per barrel for it to be economic. And while the project is not expected to come online until 2017, the outlook for Brent remains bleak, with 2017 futures trading at $70 to $73 per barrel.

The end result is that Teck is still obligated to make a considerable investment in the project before production commences, yet at current prices it appears uneconomic. Furthermore, this investment will remain a burden for Teck, which looks set to struggle with softer commodity prices for the foreseeable future.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Matt Smith has no position in any stocks mentioned.

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