DBRS Upgrades Teck Resources Ratings to BBB and Changes Trends to Stable

DBRS has today upgraded the Issuer Rating and the rating of the Senior Unsecured Notes of Teck Resources Limited (Teck or the Company) to BBB with a Stable trend from BBB (low) with a Positive trend. Teck’s ratings and Stable trend reflect the Company’s solid business profile as a leading producer of coal used in steelmaking (metallurgical or coking coal) and its diversification as a significant zinc and copper producer. The rating upgrades reflect the marked recovery in Teck’s liquidity and financial metrics after they were weakened by the recession of 2008–2009, which began just as the Company completed its $13.6 billion acquisition of the outside interests in its coal operations held by the Fording Canadian Coal Trust (the Fording acquisition), funded in large part by short-term borrowings. The trend has been changed to Stable with DBRS’s expectation that Teck will maintain its financial strength during its impending expansion phase.

DBRS downgraded Teck’s debt ratings to BBB from BBB (high) in February 2009 and to BBB (low) in April 2009 as the burden of high Fording acquisition-related debt was met with a sharp downturn in coal, copper and zinc prices because of the recession, resulting in severely weakened liquidity and credit metrics for the Company. However, Teck undertook a number of initiatives in 2009 to improve liquidity and reduce its debt, including the divestiture of non-core assets, substantially curtailing capex suspending and dividends, issuing $1.7 billion in equity and restructuring its acquisition financing, including the issuance of $4.2 billion in medium-term notes to support liquidity. These measures helped reduce net debt by $5.3 billion (or 56% of the net year-end 2008 debt) by the end of 2009.

Despite the constraints of acquisition-related debt, Teck’s operations performed well (even during 2009), generating more than $2.0 billion in operating cash flow and more than $700 million in net free cash flow in each year from 2006 to 2010. The then-annual nature of coal price sales contracts and added sales volumes from the Fording acquisition served to mitigate the impact of the downturn.

With a 15% rebound in average realized coal prices and record average annual copper prices in 2010, Teck’s operating cash flow increased by 19% over 2009 levels to $2.7 billion. In 2010, capex remained moderate, and reinstated dividends and distributions to non-controlling interests were less than 10% of operating cash flow. In addition, the Company carried on its divestiture program, generating $1.2 billion in cash from sale proceeds, which, combined with $1.7 billion in net free cash flow, was used to reduce net debt by a further $2.6 billion.

H1 2011 results have shown a similar buoyant picture, with the Company generating operating cash flow at a record pace ($3.8 billion annualized) despite several operational issues in its Coal unit leading to sales volumes that were below expectations. The Company has transitioned from a balance-sheet-repair mode to an expansion mode, seeking to increase output mainly in its Coal, Copper and Energy units over several years. Although capital expenditures have increased to an annualized rate of $1.0 billion (and are expected to grow further), net free cash flow in the first half of 2011 remained distinctly positive at $497 million.

As a result, Teck’s financial metrics in the first half of 2011 have improved significantly from 2009–2008, with the total debt-to-capital ratio declining to a moderate level at 22.0% (2009: 35.4%; 2008: 53.9%); EBITDA interest coverage standing solidly at 12.2 times (x; 2009: 5.5x); and the cash flow-to-debt ratio improving to 0.80x (2009: 0.29x). The Company’s key credit metrics are either solidly within or stronger than DBRS’s BBB rating category.

DBRS changed the trend on Teck’s ratings to Positive on April 15, 2010 (see, “DBRS Upgrades Teck Resources Issuer Rating to BBB (low) and Changes Trend to Positive”), citing the potential of a rating upgrade upon the confirmation of further debt reduction and demonstration of the Company’s ability to maintain solid profitability from its coal operations. In addition, at that time, DBRS expressed its concern that Teck faced a potential suspension of its Red Dog zinc operation in Alaska due to permitting issues in a new mining area.

Since then, Teck has significantly reduced its indebtedness. As well, metallurgical coal prices have successfully moved from an annual pricing format to a quarterly pricing format, which is expected to increase the volatility of the Company’s earnings; however, they have remained high because of strong world steel production and various supply interruptions. In addition, Teck’s Red Dog zinc operation has begun mining in the new Aqqaluk pit (which is expected to provide sufficient ore to enable operations to continue for about 20 years) despite ongoing debate over permitting issues.

With DBRS’s expectations that Teck is now better able to withstand the expected added volatility of metallurgical coal prices and that mining in the Aqqaluk pit will continue, DBRS views the upgrade of Teck’s ratings to BBB with a Stable trend as warranted.

Although Teck has a somewhat narrower business profile than prior to the Fording acquisition and the spin-out of its gold operations (minor), the outlook for the Company’s coal and copper businesses is strong and its zinc operations are also expected to contribute to healthy operating cash flow despite growing inflationary cost pressures and the negative cost impact of a stronger Canadian dollar.

Nevertheless, the Company has embarked on an expansion program to increase coal production by about 25% and copper production by about 33% and to begin initial oil production from the Canadian oil sands, all by 2016. Capital expenditures, which have been moderate in the last couple of years, are expected to rise significantly. In addition, in June 2011, the Company announced a normal-course issuer bid to buy up to 40 million of its shares, which, if completed, could cost about $1.8 billion, potentially adding to the financial risk of the Company.

The global economic situation remains troubled, with financial concerns in Europe and a general drive toward restraint, which may negatively affect commodity prices. Accordingly, DBRS expects that Teck will remain prudent in the execution of its expenditure programs in order to preserve the Company’s liquidity and the strength of its financial metrics.

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

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