DBRS Upgrades Teck’s Ratings to BBB (low) and Changes Trends to Stable

DBRS Limited (DBRS) upgraded Teck Resources Limited’s (Teck or the Company) Issuer Rating to BBB (low) from BB (high) and Senior Unsecured Notes rating to BBB (low) from BB, as well as withdrew its Guaranteed Senior Unsecured Notes rating for the reason described below. DBRS also changed the trend on the Issuer Rating and Senior Unsecured Notes rating to Stable from Positive. DBRS notes that in December 2018, Teck provided notice to the holders of its 8.5% June 2024 Senior Unsecured Notes (referred to by DBRS as the Guaranteed Senior Unsecured Notes) that all of the subsidiary guarantees granted in favour of the creditors under the Guaranteed Senior Unsecured Notes had been released. The effect of the release was to cause the Guaranteed Senior Unsecured Notes to be structurally equal to Teck’s other senior unsecured notes (previously referred to by DBRS as the Senior Unsecured Notes). As such, DBRS discontinued the rating of the Guaranteed Senior Unsecured Notes because, with the release of the subsidiary company guarantees, all of Teck’s senior unsecured notes are structurally equal and thus represent only one security line, to be henceforth described by DBRS as the Senior Unsecured Notes.

The upgrades are driven by four factors: (1) significant de-leveraging ahead of sanctioning the Quebrada Blanca Phase 2 (QB II) project by reducing gross debt to $5.5 billion as at the end of 2018 from $9.6 billion as at the end of 2015; (2) stronger-than-expected seaborne-traded hard coking coal prices that have, since the date of DBRS’s last annual review at the end of Q3 2018, averaged approximately USD 210 per tonne (Bloomberg Australia Hard Coking Coal Low Vol FOB Hay Point Swap BOM) compared with DBRS’s forecasts at the time of approximately USD 148 per tonne; (3) the favourable project finance structure of the QB II financing that only requires an additional USD 693 million of equity contributions by Teck and no cash payments until 2020 ahead of the expected project start-up in 2022; and (4) a stable to moderately positive outlook for Teck’s other commodities. The change to Stable trends is based on Teck not having any significant debt maturities until 2024 when the QB II project should be in commercial production. As a result of the Company’s Issuer Rating now being investment grade, no recovery analysis was performed with respect to Teck’s Guaranteed Senior Unsecured Notes and Senior Unsecured Notes, with the associated Recovery Ratings of RR1 and RR4, respectively, being withdrawn.

The current 2019 Bloomberg consensus benchmark estimates (as of March 25, 2019) for Australian hard coking coal is USD 147 per tonne. As of March 25, 2019, the year-to-date average reported Australian hard coking coal price was USD 205 per tonne. As such, DBRS estimates that hard coking coal prices would have to immediately decline to approximately USD 130 per tonne and stay at that level for the remainder of 2019 in order for the consensus estimate to actualize. The higher coking coal prices have been supported, in part, by the “flight to quality” by steel mills that are seeking high-quality raw material inputs in order to reduce pollution and improve blast-furnace efficiency. DBRS believes that this is a structural change in market demand and will be driven by China going forward. That said, hard coking coal prices appear to have begun to seasonally weaken, with “The TEX Report” recently reporting that premium hard coking coal traded on March 22, 2019, on the globalCOAL trading platform at USD 195 per tonne for July 2019 delivery, but DBRS expects any seasonal or other weakness as falling well short of the USD 130-per-tonne price referenced above.

Additionally, DBRS notes that the forward curve (as of March 28, 2019) for coking coal futures on China’s Dalian Commodity Exchange forecast coking coal prices to average USD 192 per tonne over the next 12 months, or about 30% higher than the Bloomberg consensus forecasts of approximately USD 142 per tonne over the same time frame. As a result, DBRS believes that Teck will potentially benefit from much stronger EBITDA and adjusted cash flow than DBRS’s current estimates, potentially delivering windfall cash in the range of the QB II equity-funding requirements. DBRS notes that the Dalian futures and Bloomberg consensus estimates are for the highest-quality low-volatile hard coking coals, and Teck typically receives modest-to-moderate discounts to these benchmarks as the majority of its saleable coal is medium-volatile coking coal blends.

DBRS believes that the outlook for Teck’s other commodities is stable to moderately positive. After bottoming in November 2018 at below USD 15 per barrel, Western Canadian Select heavy oil prices have recovered to the USD 50-per-barrel range, which should result in positive cash flow from Teck’s 21.3% interest in the Fort Hills oil sands operations. Zinc and copper inventories at London Metal Exchange (LME) warehouses are currently at the lowest levels since 2007, and both markets are projected by industry study groups to be in deficit this year. DBRS notes that the benchmark 2019 zinc treatment charge (TC) has reportedly settled at USD 247 per tonne of concentrate, or about USD 100 per tonne higher than the 2018 TC. While the higher TCs are positive for Teck’s Trail smelter, the Company produces more zinc concentrate than it refines. That said, DBRS believes that the low LME inventories are supportive of the Bloomberg consensus forecast zinc prices in the USD 1.25-per-pound to USD 1.30-per-pound range over the next few years. Teck’s copper production is expected to be relatively flat until QB II comes onstream. However, DBRS believes that the outlook for copper remains stable to moderately positive, underpinned by the copper market potentially remaining in deficit this year, due in part to the transition to underground mining at Freeport-McMoRan’s Grasberg mine in Indonesia that is expected to reduce copper concentrate production by up to 900,000 tonnes in 2019. As well, Codelco’s mines in Chile are expected to produce less due to lower copper grades, further pressuring the market into deficit. Additionally, demand should benefit from what is expected to be accelerating demand growth in coming years from the electric vehicle and lithium ion battery industries, all of which DBRS believes supports the current Bloomberg consensus estimates of at least USD 3.00 per pound from 2020 until 2022.

Teck’s business risk assessment factors remain solid in the BBB range. In 2018, Teck’s key credit metrics were very robust for the ratings, with adjusted cash flow-to-debt and debt-to-EBITDA in the “A” range and EBITDA interest coverage at the high end of the BBB range. These credit metrics are expected to weaken modestly in 2019, mainly due to lower forecast coking coal and zinc prices, but remain robust for the ratings. However, in 2020, the QB II project is expected to begin drawing down its USD 2.5 billion (100% basis) project debt facility. As such, Teck’s debt is expected to begin to increase, and EBITDA and adjusted cash flow are expected to decline based on DBRS’s current 2020 forecast for USD 128-per-tonne metallurgical (met) coal prices, resulting in Teck’s adjusted cash flow-to-debt and debt-to-EBITDA declining to the BBB category. This situation is expected to improve in 2021 as the further increases in debt are expected to be more than offset by the forecast met coal prices rising to USD 162 per tonne. DBRS expects pre-completion guarantees to be on a several basis, with Teck responsible for its 66.67% share of the project debt obligations only. DBRS notes that Teck’s QB II partners Sumitomo Corporation (Sumitomo) and Sumitomo Metal Mining Co., Ltd. will guarantee 5.56% and 27.77%, respectively, of the QB II project finance debt. Additionally, Sumitomo is rated A+/Stable, A-/Stable and Baa1/Stable by Fitch, Standard & Poor’s and Moody’s, respectively.

Management expects to begin pre-commercial production by the end of 2021, and during that period, DBRS expects Teck’s adjusted cash flow-to-debt metric to remain above 35% and its debt-to-EBITDA metric to be at or below 2.0 times, both commensurate with the ratings. As well, DBRS believes that rising commodity price forecasts in 2022 should result in all of Teck’s key credit metrics moving up to the “A” category. DBRS believes that if commodity prices, particularly for met coal, are actually significantly higher or lower than Bloomberg consensus estimates, then a positive or negative rating action, respectively, could result.

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

The principal methodology is Rating Companies in the Mining Industry (September 2018), which can be found on dbrs.com under Methodologies & Criteria.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at info@dbrs.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.

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