DBRS Downgrades Teck Resources Unsecured Debentures to BBB (low) with Negative Trend

DBRS has today downgraded the Unsecured Debentures rating of Teck Resources Limited (formerly, Teck Cominco Limited; Teck or the Company) to BBB (low) from BBB and maintained a Negative trend. DBRS is concurrently assigning an Issuer Rating of BB (high) with a Negative trend, meaning that our opinion on the default risk of Teck has declined from BBB to BB (high). The higher BBB (low) rating for the Unsecured Debentures is a reflection of DBRS’s Rating Methodology for Leverage Finance, which is used for entities that have a non-investment-grade issuer rating. Under this methodology (as described below), DBRS has assigned a RR3 recovery rating to Teck’s Unsecured Debentures, which indicates an expected 50% to 70% recovery under a distress scenario and results in the Unsecured Debentures being rated one notch higher than the issuer rating. These negative rating actions reflect Teck’s weakened financial risk profile, the Company’s high debt levels and DBRS’s outlook for poorer than previously expected commodity markets, particularly for steel-making coal. In addition, it is DBRS’s opinion that a proposed rescheduling of the bulk of the Company’s debt obligations would only partially resolve Teck’s near-term liquidity concerns.

Teck’s Unsecured Debentures rating was downgraded from BBB (high) with a Negative trend to BBB with a Negative trend on February 17, 2009. At that time, DBRS indicated that Teck’s then current and projected credit metrics were weak for a BBB rating. The Company faced serious challenges in reducing debt by way of asset sales in a very difficult commodity market environment. Additionally, the expectation was that if asset sales were to be realized, they could weaken the Company’s business profile. DBRS’s outlook for Teck’s 2009 operating cash generation was not positive and was clouded by the uncertainty around metallurgical coal price negotiations for the 2009 –2010 coal sales year, which were in progress at the time. As well, DRBS expected higher interest costs on refinanced debt would put added pressure on Teck’s coverage metrics. DBRS concluded that unless Teck could stabilize its operating results in 2009 and reduce its leverage, further negative rating action would have been likely.

Since the February 17, 2009, rating action, Teck has had (1) Q1 2009 results from the Company’s coal operations that were much poorer than DBRS expected; (2) further deterioration of the Company’s credit metrics; (3) continuing high debt levels; (4) a lack of progress in reducing or refinancing (terming out) the acquisition debt used to finance the October 2008 acquisition of interests in the assets of Fording Canadian Coal Trust (Fording); and (5) continuing liquidity concerns and expected added financing costs even though the Company has received commitments from lenders to amend the terms of bridge and term loans associated with the Fording acquisition. In addition, DBRS’s near-term outlook for steel-making (metallurgical) coal markets has deteriorated, with both demand and prices lower than previously expected due to the worldwide downturn in the steel industry.

Teck made two significant announcements on April 21, 2009: (1) Q1 2009 operating results, including coal price settlements with a number of customers for the 2009–2010 coal year, and (2) the signing of a commitment letter with most of the lenders of its existing US$4 billion senior term loan facility (Acquisition Term Facility) and US$5.81 billion senior bridge loan facility (Bridge Facility) to amend the facilities, including the extension of term and the delay of major repayments of the facilities originally scheduled for 2009. Neither announcement fully resolves DBRS’s concerns with respect to Teck’s near-term liquidity nor its prospects of reducing its high debt levels in a weakening coal market environment.

DBRS had expected that coal would be the most important contributor to Teck’s Q1 2009 operating profits due to the term nature of export coal pricing and the Company’s increased participation in coal, but its coal results were much weaker than expected. First-quarter sales tonnage was 3.7 million tonnes, well below the average quarterly level of the Company’s guidance of 20 million tonnes for full-year 2009. In addition, first-quarter coal sales included only about 2.1 million tonnes of Teck’s top brands of coal sold at high 2008–2009 contract prices, with 0.6 million tonnes of lower-priced thermal coal and 0.7 million tonnes of metallurgical coal sold at much lower 2009–2010 contract prices and 0.3 million tonnes sold at low 2007–2008 contract prices, for an aggregate first-quarter selling price of US$204 per tonne, well below the US$300 per tonne benchmark for top-quality metallurgical coal for the 2008–2009 coal year. Production costs for coal were $97 per tonne for the first quarter of 2009, similar to the 2008 average, but they were higher than expected given a significant decline in input costs such as diesel fuel.

Copper and zinc operations provided better-than-expected Q1 2009 contributions to operating profit despite lower prices in the marketplace. Compared with Q4 2008 results, negative price adjustments, booked to sales revenue as a result of declining metal prices, were much less a factor, aiding in the improvement shown.

Overall, Teck’s cash from operations for the first quarter of 2009 totaled $560 million. Working capital contributed an additional $567 million, primarily due to the receipt of approximately $801 million of a total expected $1.1 billion tax refund. Capital expenditures for the first quarter included $64 million for sustaining capital, $68 million of expansion and project expenditure and $226 million on the Fort Hills Oil Sands (Fort Hills) project in Alberta. DBRS expects that 2009 sustaining capital and expansion and project expenditures for existing operations will total $500 million. In addition, it is expected that Fort Hills expenditures will decelerate significantly for the rest of 2009, resulting in a total outlay of $330 million for the year. Despite net cash generation of $873 million before financing activities, net debt at the end of the first quarter was only marginally lower at $11.6 billion compared with $12.0 billion at December 31, 2008. A fall in the value of the Canadian dollar from year-end 2008 to the end of the first quarter of 2009 resulted in a smaller decrease in debt than expected given the significant tax refund and asset sale proceeds received since much of Teck’s debt is denominated in U.S. dollars.

With the continued resilience of Teck’s copper and zinc operations shown in the first quarter and with reduced but reasonable contributions from coal due to lower prices for the rest of 2009, DBRS expects that Teck will be able to modestly improve its gross leverage of 54% at end of the first quarter of 2009 to less than 50% by year-end. That said, significant uncertainty for the Company remains.

Our expectations include a recovery of coal sales for the rest of the year of approximately five million tonnes a quarter and a mix of brands sold to yield a weighted-average of approximately US$120 per metric tonne sold based on Teck’s announced price of $US128 per tonne for its highest-quality coal. Teck has indicated that the issue of carry-forward tonnage from the higher-priced 2008–2009 coal contract year has not been resolved. We have not factored in any carry-forward tonnage, hence there is some upside pricing potential. On the other hand, our expectations include a recovery of shipment volumes from the low levels of the first quarter. The steel industry remains in flux due to weak economic conditions throughout the world. Additionally, the 2009–2010 price achieved for hard coking coal is the second highest price on record, hence subject to some risk in the 2010–2011 coal contract negotiations. Any setback in the recent recovery of copper, zinc and lead prices would also add to the Company’s challenges.

As prescribed under the Rating Methodology for Leverage Finance, DBRS has simulated a default scenario for Teck in order to analyze the potential recovery for the Company’s debt in the event of default. The scenario assumes a further deterioration in commodity prices in 2010 and in particular a reduction in export coal prices for the 2010–2011 coal year, combined with an inability for Teck to access new funding sources or achieve meaningful asset sales, resulting in an inability for the Company to meet its loan repayment and covenant obligations in the fall of 2010, which would result in default. In its analysis, DBRS assumes that the Company would be reorganized as a going concern following the event of default. It should be noted that although Teck’s debt obligations are currently unsecured, the amendments to the Bridge Facility and the Acquisition Term Facility contemplate the introduction of a first-priority security interest related to the facilities. DBRS has assumed in its recovery analysis that Teck’s revolving credit facilities, Unsecured Debentures, Bridge Facility and Acquisition Term Facility would continue to rank parri passu whether under a first-priority security as contemplated or as unsecured facilities as they are now structured. Of Teck’s current debt instruments, only the Antamina senior revolving credit facility ($113 million at December 31, 2008) and other debt ($91 million of largely capital leases at December 31, 2008) are considered ranking ahead of the Unsecured Debentures.

Based on the estimated amount of debt outstanding and the ranking of Teck’s debt instruments at the time of default, DBRS has forecast the economic value of the enterprise using a five times multiple of normalized EBITDA to derive a forecast recovery for holders of the Unsecured Debentures. Accordingly, DBRS has assigned a recovery rating of RR3 to the Unsecured Debentures, which corresponds to a forecast recovery of between 50% and 70% of principal amounts.

Teck’s announced major restructuring of its Acquisition Term Facility and Bridge Facility remains subject to a number of closing conditions, although commitment letters have been received from 83.6% of the lenders. The amendments would serve to reduce the size of Teck’s 2009 funding requirements of US$6.3 billion to approximately US$1.9 billion. With $1.6 billion cash on hand and approximately $1.1 billion in unutilized credit facilities at the end of the first quarter of 2009, DBRS expects that the amendments, if implemented as indicated, would allow Teck to adequately meet the revised maturity obligations. Nonetheless, the amendments would not serve to resolve the Company’s high leverage and will add to financing cost through extension fees of approximately US$96 million and higher interest costs. DBRS expects additional reductions of the Bridge Facility through asset sales or term refinancing to occur during the year.

There is a wide range of other features of the new lender commitments that would focus much of Teck’s cash generation, funding from new debt, asset sales and tax refunds related to the Fording acquisition to repayment of Bridge Facility obligations.

Teck’s current and projected credit metrics are weak for a BB (high) issuer rating. The amendments to the Bridge Facility and the Acquisition Term Facility provide the Company relief from its near-term maturity obligation, but they are not fully resolved. Completion of the current credit amendments needs to be achieved and further re-financing is required to term out the Bridge Facility loan. The Company continues to face serious challenges in reducing debt by way of asset sales in the current market environment and if asset sales are realized, they could weaken the Company’s business profile. The outlook for 2009 operating cash generation is modest and is subject to the greater-than-normal uncertainty in the current economic climate. Additionally, higher interest costs on refinanced debt will put further pressure on coverage metrics. Accordingly, Teck’s ratings remain on Negative trend with the possibility of further negative rating actions.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Mining, which can be found on our website under Methodologies.

This is a Corporate rating.