A Top Energy Buy for 2013

02/12/2013 9:00 am EST

Focus: COMMODITIES

Patrick McKeough

Editor, Successful Investor

As demand for energy rises, Patrick McKeough of TSI Network selects a major coal producer as his Stock of the Year.

We’ve chosen Teck Resources (Toronto: TCK.B), a leading producer of metallurgical coal—a key ingredient in steelmaking—as our Stock of the Year for 2013.

Its six coal mines (five in British Columbia and one in Alberta) should last from six to 75 years. We feel the company’s high-quality, long-lasting reserves and potentially higher commodity prices in 2013 make it a particularly attractive buy right now.

In 2011, coal accounted for 49% of Teck’s revenue and 57% of its earnings. Teck also produces copper (27%, 28%), which its clients in Asia and Europe use to make electrical wire, auto parts, and components for electronic devices. As well, Teck is a major supplier of zinc (24%, 15%), which prevents rusting when added to steel.

Teck’s revenue jumped 80.7%, from $6.4 billion in 2007 to $11.5 billion in 2011. That’s largely because it bought the 80.05% of Fording Canadian Coal that it didn’t already own in 2008. Increasing urbanization in Asia also spurred strong demand for commodities like coal and copper.

Recovering commodity prices and savings from a restructuring plan helped push up Teck’s earnings to $2.5 billion, or $4.18 a share, in 2011.

Beginning in 2010, Teck began negotiating coal prices with its customers on a quarterly basis, instead of annually, giving it more flexibility to adjust its production to better match demand.

Teck’s coal tends to burn more steadily than coal from its main competitors, so the company can charge higher prices. As well, demand for its higher-quality coal should keep rising, particularly as Chinese steelmakers modernize their blast furnaces. Moreover, the company continues to do good job of controlling its costs, helping it stay profitable if coal prices fall.

Teck is also putting itself in a good position to take full advantage when coal prices rise again. It aims to reopen its Quintette coal mine in northern British Columbia in the second half of 2014. That would increase its annual production by around 12%.Quintette’s reserves should last for 12 years.

The company is also adding to its copper operations, including an expansion that could double the output of its 76.5%-owned Quebrada Blanca mine in Chile. This project would cost $4.8 billion, but it would add 30 years to the mine’s life. If Teck goes ahead, it could start up in 2017.

In addition, Teck is evaluating a second copper project in Chile called Relincho. This wholly owned mine could raise the company’s annual copper output by 50%, with reserves lasting 22 years.

Teck continues to invest in projects that help it diversify beyond coal, copper and zinc. It owns 20% of the Fort Hills oil sands project; Suncor (SU) owns 40.8%, while Total (TOT) holds 39.2%. Depending on oil prices and pipeline capacity, this project could start up in 2017.

Teck also owns 100% of the Frontier and Equinox oil sands projects. Frontier should begin operating in 2021. Teck will then develop Equinox.

Due to the recent declines in coal and other commodity prices, Teck cut its projected 2012 capital expenditures to $1.8 billion from its earlier forecast of $2.1 billion. However, Teck’s strong balance sheet will continue to support its expansion. On September 30, its long-term debt was $7.5 billion, or a manageable 35% of its market cap.

The company continues to redeem high-yield bonds related to the Fording purchase. That will hurt its short-term earnings, but it will also cut its long-term interest costs.

Teck’s 2012 earnings probably fell to $1.60 a share. However, lower costs could push up its 2013 earnings to $2.75 a share. The higher earnings and cash flow would let Teck keep increasing its dividend. The current annual rate of 90 cents a share yields 2.4%.

Subscribe to The Successful Investor here...

Related Reading:

Commodity ETFs or Futures?

China Can't Get Enough Silver

Watch This Lagging Leading Indicator

Related Articles on COMMODITIES