Teck Resources Ltd. (TSX:TCK.B)(NYSE:TCK) started 2016 at $5 per share and currently trades for more than $20.
That’s a huge run, and many pundits believe the rally is way out of control. At first glance, that’s a fair comment to make, but some interesting developments in the company’s core markets suggest more upside could be on the way.
Let’s take a look at the current situation to see if Teck has what it takes to extend the surge through the end of the year.
Commodity prices
Teck produces coking coal, copper, and zinc.
For most of the past five years, these three commodities have been in a nasty slump, but 2016 appears to be the end of the rout.
Coking coal (also known as metallurgical or steel-making coal) was in its worst slump since the 1950s before the market staged a surprise rally this year.
The surge has come on the back of better steel margins, stronger demand in India, and lower production from China. New regulations that limit working days for coal miners in China have had the largest impact on the market.
Teck’s average realized coal price for Q2 2016 was US$83 per tonne–up from US$75 per tonne in the first quarter. The Q3 benchmark settlement price is above US$90 per tonne, so the trend is moving in the right direction.
The coal spot price has surged in recent weeks amid concerns of a global supply crunch and that bodes well for Teck going into the fourth quarter.
How hot is the coal market?
Prices broke through US$170 per tonne in recent trading. That’s the highest price the market has seen in nearly three years.
Miners get most of their coal revenue based on quarterly contracts, rather than spot prices, so Teck isn’t going to suddenly see its realized sale price double, but there is a good chance Teck will negotiate significantly higher settlement prices for the coming quarters, and the market probably hasn’t fully accounted for that possibility.
If analysts start to revise earnings expectations to the upside, Teck could catch another tailwind heading into 2017.
What about copper and zinc?
Copper hasn’t performed as well, but the metal appears to have found a bottom and is trading in a range between US$2 and US$2.30 per pound. Analysts are split on whether or not a recovery is in the works. For the moment, it looks like copper will bounce along its current path.
Zinc has been on fire this year, surging more than 40% on the back of reduced output and strengthening demand. Most market observers expect the rally to continue into next year.
Financials
Teck has done a good job of reducing costs through the downturn and has remained profitable, despite the tough market conditions. As commodity prices recover, Teck’s margins should expand significantly.
Debt has been a big overhang on the stock, but the company recently issued US$1.25 billion in new bonds and used the funds to retire notes that were coming due over the next three years. This should take care of any concerns the market had regarding a potential cash crunch.
Liquidity remains strong with US$3 billion in available credit and $1.4 billion in cash. Teck now has the funds needed to meet its commitments on the Fort Hills oil sands development, which is expected to begin production in late 2017.
Will Teck hit $30?
Betting on a run to $30 by the end of the year is a bit of a stretch, but investors shouldn’t assume the rally has run its course, especially if recent gains in coal prices prove to be sustainable over the medium term.
I wouldn’t back up the truck right now, but investors who own the stock might want to stay invested. The recovery could still be in its early innings.
