Teck Resources Limited (TCK.B C$24.41, TSX) Focus on balance sheet safety; reiterating Buy rating and C$35 target

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1 Teck Resources Limited (TCK.B C$24.41, TSX) Focus on balance sheet safety; reiterating Buy rating and C$35 target John Hughes (416) Bill Mantzoutsos, CFA, Associate (416) The Desjardins Takeaway We are reiterating our Buy Average Risk recommendation on the shares of Teck after the company released its 2Q13 results. Adjusted EPS during 2Q13 met our and consensus expectations of C$0.34, and management highlighted its focus on minimizing balance sheet risk through We applaud this strategy, including the deferral and/or postponement of two major project developments in response to weaker commodity markets. Our Buy Average Risk recommendation is unchanged. Highlights 2Q13 adjusted EPS of C$0.34 meets expectations. The company reported EPS of C$0.25 for the quarter. The various adjustments we make to arrive at EPS of C$0.34 are highlighted in Exhibit 1. The company s coal division accounted for ~60% of EBT during 2Q13. We estimate the revaluation of inventory or price settlement adjustments during 2Q13 resulted in a C$0.07 impact on after tax EPS. Key highlights for 2Q13 results and conference call include: Focus now clearly on balance sheet management. Teck announced a deferral of development at two major projects, including a one year delay (at least) for the US$5b QB2 copper project in Chile and an open ended delay on construction/development at the C$865m Quintette coal project in BC. Metallurgical coal price appears to be bottoming, according to Teck management. Evidence includes a narrowing of the spot price vs the contract price (US$11/t spread vs average of US$20 30/t) and a slight improvement in demand at the current spot price. Capex reduction of C$0.2b in 2013 (to C$2.2b) and a C$0.2b reduction in 2014 sustaining capex to C$0.5b. Capex through 2014 is directionally down. Management stated it is not currently focused on any major acquisitions, including the Las Bambas copper project put up for sale (estimated US$4 5b) by Rio Tinto. Balance sheet remains strong. Teck ended 2Q13 with C$2.8b in cash, C$7.6b in debt and a debt to debt plus equity ratio of 0.29, up slightly from 0.28 at the end of 1Q13. Debt repayments amount to only C$304m over the next three years. Management stated the existing dividend of C$0.90/year remains a major priority and will not be put at risk with future acquisitions or capex required for project development, including the Fort Hills oilsands project. According to management, the question is not if the dividend will be cut, but rather when the dividend will be increased assuming no major changes in commodity prices from current levels. Management ups coal production guidance for Teck s guidance for 2013 includes a 0.5m tonne increase in coal production to 25m tonnes (mid point) from 24.5m tonnes previously. Copper and zinc production remains unchanged at 350,000t of copper and 860,000t of zinc. Teck Resources Limited Rating Buy Average Risk Target C$35.00 Symbol TCK.B Exchange TSX Closing price C$24.41 Potential return 41% 52 week range C$ Shares O/S 582m Market cap C$14,207m Year end Dec 31 Revenue 2013E C$9,561m 2014F C$10,657m EPS 2013E C$ F C$2.80 P/E 2013E 14.7x 2014F 8.7x Book value/sh C$31.67 Debt/debt+equity 29% Dividend C$0.90 Dividend yield 3.7% Quarterly data EPS 3Q13E Desjardins C$0.35 Consensus C$0.34 EPS 3Q12A C$0.60 Source: Desjardins Capital Markets Valuation We reiterate our unchanged C$35 target and highlight Teck as our senior play on metallurgical coal. We arrive at our target price by applying a 12.5x P/E multiple (well within historical norms) to our 2014 EPS estimate of C$2.80. We are maintaining our 2014 average realized metallurgical coal price of US$170/tonne, copper price of US$3.75/lb and zinc price of US$1.00/lb. Additionally, our forecast C$/US$ exchange rate at par remains unchanged. Recommendation We highlight our unchanged Buy Average Risk recommendation and C$35 target price for Teck s shares. This report was prepared by an analyst(s) employed by Desjardins Securities Inc., and who is (are) not registered as a research analyst(s) under FINRA rules. Please see disclosure section at the end of this publication for companyspecific disclosures, analyst certification and legal disclaimers. 1

2 Exhibit 1: 2Q13 adjusted EPS 2Q13 reported EPS (C$) 0.25 Asset sales & provisions 0.03 Foreign exchange 0.03 Tax items Q13 adjusted EPS (C$) 0.34 Operational overview Coal assets remain the primary contributor to revenue and gross profit. Teck s coal assets were the company s primary contributor to both revenue and gross profit in 2Q13 (see Exhibits 2a and 2b). Exhibit 2a: 2Q13 consolidated revenue by division Exhibit 2b: 2Q13 gross profit by division Coal 47% Copper 32% Coal 48% Copper 41% Zinc 21% Zinc 11% Coal assets 48% of gross profit in 2Q13. Gross profit during 2Q13 was C$277m, down from C$346m in 1Q13. This was due to a combination of lower coal volumes sold in the quarter (6.3m tonnes vs 6.6m tonnes) and lower sequential average selling prices (US$156/tonne vs US$161/tonne). During 2Q13, coal production was 6.0m tonnes vs 6.2m tonnes in 1Q13. Total coal production costs, including depreciation and amortization, were US$115/tonne, slightly down from 1Q13 (US$120/tonne). Unit production costs and unit transportation costs were US$50/tonne and US$39/tonne, respectively, compared with US$47/tonne and US$36/tonne in 1Q13. Note that in the current quarter, depreciation and amortization increased by US$4/tonne to US$26/tonne, primarily due to the significant increase in capital assets to be depreciated under the new capitalized stripping accounting standards. Management maintained guidance for the annual cost of product sold of C$51 58/tonne and annual transportation cost forecast of C$36 40/tonne in Teck expects to reach agreements with its customers to sell at least 6.4m tonnes of coal in 3Q13 at an average price of US$143/tonne compared with an average realized price of US$156/tonne during 2Q13. This compares with the current spot price of US$132/tonne. Management did increase its met coal production guidance for The company s range is now m tonnes (was previously m tonnes). We forecast sales of 26m tonnes. The company announced that given current market conditions, it has decided to delay a final decision to place Quintette into production. The revised project plan will defer C$300m of planned capex in 2013 and an additional C$350m in the first part of If the decision to proceed with the reopening of the mine occurs in early 2014, Quintette could potentially be in commercial production during 2H15 (vs 1H14 previously). The possible restart of the Quintette coal project would result in production of 3.5m tpy over a 12 year minelife. Zinc assets 11% of gross profit in 2Q13. Zinc production in 2Q13 at Red Dog was 138,700 tonnes, higher than 1Q13 production of 128,200 tonnes due to increased mill throughput and improved mill 2

3 recoveries. Contained zinc sales decreased to 75,100 tonnes (above prior expectations for ~74,000 tonnes of zinc) from 107,400 tonnes in 1Q13, as the 2013 shipping season commenced on July 2. Red Dog s sales volumes of contained zinc metal are estimated at ~180,000 tonnes in 3Q13. Production of zinc at Trail was 70,400 tonnes, down sequentially from 74,400 tonnes in 1Q13. Sales were also lower, coming in at 70,300 tonnes during the quarter, vs 72,900 tonnes in 1Q13. As a result, gross profit during the quarter did decrease to C$4m from C$29m, remaining low as a result of both lower zinc and substantially lower silver prices and sales volumes. There was no change to Trail s 2013 production forecast range of 280, ,000 tonnes of refined zinc. The company has also not altered its 2013 zinc production guidance of 840, ,000 tonnes at this time (compared with actual zinc production of 882,000 tonnes in 2012). Copper assets 41% of gross profit in 2Q13. Teck owns/operates four major copper operations, discussed below. Gross profit at the 97.5% owned Highland Valley copper mine was C$62m, down significantly from US$101m in 1Q13. The sequential decline was primarily due to lower copper prices, reduced molybdenum revenues and slightly lower sales volumes. Profitability was also hurt by lower copper production of 25,500 tonnes, which declined significantly from the 28,500 tonnes produced in 1Q13, primarily as a result of lower mill throughput and lower ore grades. Highland Valley s forecast copper production in 2013 is unchanged in the range of 100, ,000 tonnes of copper. The C$550m mill optimization project is progressing well, with construction now reported to be over half complete. Recall the company is modernizing its existing 40 year old mill at Highland Valley, which is anticipated to increase mill throughput by 10% and copper recovery by 2%. Construction and commissioning is still scheduled for completion by 4Q13. The 22.5% owned Antamina mine posted a gross profit of C$128m, up significantly from C$97m in 1Q13, due primarily to substantially higher copper production and sales volumes. Copper production for the quarter was 106,900 tonnes, up from 77,300 tonnes in 1Q13. Sales this quarter were 98,200 tonnes, compared with 74,200 tonnes in the prior period. Tonnes milled in the quarter averaged ~137,000 tonnes per day, with throughput ~19% higher than 1Q13 as maintenance problems were resolved. Gross profit at the 76.5% owned Quebrada Blanca mine increased to C$16m from (C$5m) in 1Q13. Sales during the quarter increased to 16,900 tonnes vs 10,100 tonnes in 1Q13. The increase in gross profit (before depreciation and amortization costs) led to Quebrada Blanca returning to profitability in the quarter, as a result of significant decreases in labour costs and operating costs stemming from initiatives undertaken in 4Q12 to reduce workforce at the operation. Recall that the mine has transitioned from a high grade heap leach operation to a lower grade dump leach operation, and company management has acknowledged that challenges will remain as Quebrada nears the end of its mine life (see Quebrada Blanca 2 below). Gross profit at the 90% owned Carmen de Andacollo mine decreased to C$31m, from C$56m in 1Q13, primarily due to higher copper sales (18,500 tonnes in 2Q13 vs 21,400 tonnes in 1Q13). This was aided by production levels that were in line, a result of relatively constant mill throughout and unchanged recovery rates. Andacollo s copper production forecast for 2013 remains unchanged at 50,000 60,000 tonnes of copper. The company has also left unchanged its total 2013 copper production guidance of 340, ,000 tonnes, compared with actual copper production of 373,000 tonnes in

4 Copper development projects Quebrada Blanca Phase 2 (QB2) Teck s next major mining project. During 2Q13, Teck continued with the detailed design of its 76.5% owned QB2 project. Initial capex estimate is maintained at US$5.6b, of which Teck s portion is US$4.8b. Recall that Quebrada Blanca is currently transitioning from a high grade heap leach operation to processing an increasing proportion of lower grade dumpleach ore. The project will involve the construction of a 135,000tpd concentrator to be connected to a new port facility by a 165km pipeline. Production at QB2 is targeted at 200,000tpy of copper over a 39 year minelife. Management has announced its decision to delay development of the QB2 expansion project, in light of current market conditions. The submission of the Phase 2 social environmental impact assessment will not be resubmitted before the end of 4Q14 (previous guidance was for the end of 4Q13) due to permitting issues for existing facilities. The production start date remains undetermined, although 2019 appears to be the earliest possible date for initial production. Relincho. Feasibility study work at the Relincho project continued during 2Q13, and is expected to be completed by the end of 4Q13. The feasibility study will also include a new resource/reserve estimate on the back of exploration and geotechnical drilling. As a result of previous permitting delays, the progress of third party port and power supply facilities expected to be used at Relincho was delayed as well, thus pushing back the feasibility study completion timeline. Recall the pre feasibility work indicated the project would have an estimated initial capex of US$3.9b and that the first five years of mining would produce an estimated 195,000tpy of copper in concentrate, with an average of 180,000tpy over its 22 year minelife. Galore Creek (50%). The work program and budget for 2013 had been previously approved, which included regular care and maintenance activities, continued baseline environmental work and a 10,000m drill program focused on resource expansion. No updates to Galore Creek were provided this quarter. A summary of Teck s 2Q13 financial and operating results is set out below in Exhibit 3. 4

5 Exhibit 3: Summary of Teck s 2Q13 quarterly financial and operating results Year end Dec 31 2Q13 1Q13 2Q12 2Q13 comments Metallurgical coal operations Coal sales: 100% basis (000 tonnes) 6,285 6,578 6, production guidance: ~25.0mt Coal price (US$/tonne) US$143/tonne expected in 3Q13 Revenue from coal (C$m) 1,002 1,060 1,362 Gross profit from coal (C$m) Base metal operations Zinc mine + refined production (000 tonnes) production guidance: 860,000 tonnes Zinc conc sales (000 tonnes) Refined zinc sales (000 tonnes) Copper mine production (000 tonnes) production guidance: 350,000 tonnes Copper mine sales (000 tonnes) Average LME commodity prices (US$/lb) Copper Our forecast: US$3.50/lb in 2013 Zinc Our forecast: US$0.95/lb in 2013 Lead FX (C$/US$) Revenue by division (C$m) Zinc Copper Total revenue for base metals 1,148 1,269 1,198 Gross profit (C$m) Zinc Copper Total gross profit for base metals Total revenue (C$m) 2,152 2,330 2,561 Total gross profit (C$m) EBITDA/sales margin (%)

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