Commodity prices have been in the dumps for a long time. One look at the S&P/TSX Capped Materials Index tells you that. Over the past five years the trend line was straight down until early this year, falling from over 400 points to well below 200 before the turnaround. The five-year loss to June 9 was 38.2%.
But these are cyclical companies. As long as a business can survive the down cycles, it will eventually bounce back and when it does there are some quick profits to be made. That's case with this week's TSX market leader, Teck Resources (TSX:TCK.B, Financial) (NYSE:TCK). Here is the inside scoop.
Background: Teck is Canada's largest diversified resource company, with mining operations focused on copper, steelmaking coal (it is the largest North America producer), and zinc. It operates mines in Canada, the U.S., Peru, and Chile. As well, it has energy interests in the Foot Hills Oil Sands project, which is scheduled to come into production next year. The company is headquartered in Vancouver.
Stock performance: Five years ago the company's shares were trading at over $60 and seemed poised to go higher. But then growth in China began to slow down and commodity prices went into a deep slide. Teck's shares entered a long decline that did not end until January of this year when the stock hit a bottom of $3.65. But the company has been down this road before and has always recovered. It's now on that path again, gaining almost 300% since its January bottom.
Cyclical investing: Cyclical stocks can be an investor's dream or nightmare. It all depends on when you buy and sell. These are not stocks to hold in your portfolio for the rest of your life; you actively trade in and out of them depending on the economic climate. If you don't like active trading, you shouldn't be in these stocks at all.
Financial results: First-quarter profit attributable to shareholders was $94 million ($0.16 per share) compared with $68 million ($0.12 per share) a year ago. Cash flow from operations was $373 million in the quarter, about flat from last year.
The company achieved these results despite significantly lower prices for all of its products during the quarter. Steelmaking coal, copper, and zinc prices in the quarter were 29%, 20%, and 19% lower, respectively, in U.S. dollar terms, compared with a year ago. Concerns regarding a slowdown in the Chinese economy combined with an oversupply of certain commodities, especially steelmaking coal, have been major factors in the price declines. On the plus side, the stronger U.S. dollar had a positive benefit on Teck's business: sales of its products are denominated in U.S. dollars while a significant portion of its expenses are incurred in local currencies, particularly the Canadian dollar.
Coming out of the quarter, the pricing situation was starting to turn in Teck's favour. Copper and zinc were higher than at the start of the year, although steelmaking coal was still down. However, management was cautioning investors that prices might remain low for some time.
Bottom line is that despite the difficult environment, Teck has weathered the downturn in commodity prices well. It has cut its production costs at all its operations and has continued to generate profits throughout these tough times. The shares even pay a dividend, albeit a very small one at $0.10 a share annually.
Outlook: Based on the quick run up in the share price since January, investors seem to feel the worst is behind for Teck. However, I suggest you use caution. The underpinnings for a prolonged recovery are not yet in place. The copper index may be higher than in January but is down from a year ago, trading at about $2.07 a pound (it was around $2.52 last year). Zinc is working its way back to year-ago levels but it not there yet - it's currently about $0.93. As Teck's management noted, steelmaking coal is down as well. And cash flow from the company's stake in the Foot Hills Oil Sands project (in which Teck holds a 20% interest) won't start until 2017.
The company has done a good job of coping with the challenges but the rebound of almost 300% in the share price in just five months looks excessive. Teck is a good company and when the foundations are in place for a sustained run in the share price we will recommend buying again. But right now I'd stay on the sidelines, despite the rapid upturn in the share price.
