Fitch Downgrades Teck's IDR to 'BB '; Outlook Negative
A full list of rating actions follows at the end of this release.
With the slowdown in China, Fitch believes there is an elevated risk that metal and metallurgical coal prices will be lower for longer, delaying Teck's ability to generate free cash flow (FCF) and reduce financial leverage to levels where funds from operations (FFO) adjusted leverage is less than 3x and FFO fixed charge coverage is greater than 6x through 2020.
KEY RATING DRIVERS
The ratings reflect Teck's elevated financial leverage, strong liquidity, long-lived reserves, leading low cost position in zinc, leading position in the seaborne metallurgical coal market, and solid core position in copper. The ratings also reflect weak metallurgical coal pricing and softness in copper and zinc, as well as our belief that the company is likely to experience limited capex flexibility given required spending for the Fort Hills project through 2017.
Globally, Teck is the second largest seaborne hard coking coal producer after BHP-Mitsubishi Alliance and is at about the mid-point of the cost curve (FOB port). Teck is in the top 15 largest copper producers, globally, with about average costs, and is the third largest zinc producer, in the lowest quartile on costs. Mine lives are generally over 20 years.
Coal accounted for 33% and copper accounted for 39% of segment operating EBITDA in 2014. Canadian operations accounted for about 52% of 2014 gross profit before depreciation by region. Remaining operations are in the U.S. (22%), Chile (10%) and Peru (16%).
Oversupply in Metallurgical Coal:
The outlook for metallurgical coal prices is weak given persistent oversupply. Fitch expects this condition to persist through 2016 and result in lower profits and cash flow. Teck guides that a US\\$1/tonne change in its coal realizations impacts profits by C\\$21 million. For 2014, Teck realized US\\$115/tonne on its coal sales on average. For the first six months of 2015, Teck realized US\\$101/tonne and Fitch believes this could fall further before recovering in 2017. In May 2015, Teck announced rotating shutdowns totalling three weeks in the third quarter at their metallurgical coal mines. Further steps may be taken to reduce production in the fourth quarter unless the supply-demand balance improves.
Teck guides to C\\$1 billion in new mine development for 2015 including C\\$850 million for the Fort Hills oil sands project in Canada and C\\$60 million for its Frontier oil sands project. The Fort Hills project, a partnership among Suncor Energy Inc. (50.8%), Total E&P Canada Ltd. (29.2%) and Teck (20%), was sanctioned in the fourth quarter of 2013. Teck's share of the project spending from the date of project sanction is estimated at about C\\$2.94 billion for the period 2014 through 2017. Production is not anticipated to start before the end of 2017 but is expected to be at 90% capacity within 12 months.
Although oil prices remain under near-term pressure, Fitch acknowledges the diversification benefits of petroleum and recognizes the quality of the Fort Hills project. The project is expected to have cash costs in the range of C\\$20-C\\$24/barrel of bitumen, excluding sustaining capex of roughly C\\$3/barrel, and a 50-year mine life.
Total capital guidance for the year is C\\$2.3 billion including C\\$710 million of capitalized stripping and C\\$490 million of sustaining capital.
High Financial Leverage:
Fitch expects FFO adjusted leverage to be above 3x while coal prices are below US\\$125/tonne. For the latest 12 months (LTM) ended June 30, 2015, FFO adjusted leverage was 4.25x, FFO fixed charge coverage was about 5x, and total debt of C\\$9.1 billion-to-operating EBITDA of C\\$2.5 billion was 3.6x. The company targets total debt/EBITDA of less than or equal to 2.5x on average.
--Production at reduced guidance and fairly flat after 2015;
--Coal and copper unit cost decline with currency and fuel impacts as well as cost initiatives;
--Fitch's mid-cycle commodity price assumptions;
--Hard coking coal benchmark prices assumed to be US\\$95/tonne in 2016, US\\$100/tonne in 2017, US\\$110/tonne in 2018, and US\\$115/tonne thereafter;
--Capital expenditures at guidance and fairly flat through 2017 given Fort Hill's spending.
Positive: Future developments that may, individually or collectively, lead to positive rating actions include:
--The metallurgical coal market returns to balance faster than expected.
--A sustainable meaningful reduction in debt and financial leverage.
Negative: Future developments that may, individually or collectively, lead to negative rating actions include:
--Expectations of reduced economics on the Fort Hills project.
--Expectations that FFO adjusted leverage would be sustained above 4x for an extended period.
At June 30, 2015, liquidity included US\\$3 billion available under the revolving credit facility (RCF) maturing in July 2020, US\\$1.2 billion available under the RCF maturing in June 2017, and C\\$1.3 billion in cash on hand. The credit facilities require Teck to maintain a debt-to-total capitalization ratio of not more than 0.5x. At Dec. 31, 2014, the ratio was 0.31x.
On July 9, 2015, Teck announced that its 90%-owned subsidiary, Compania Minera Teck Carmen de Andacollo, entered into a long-term gold off-take agreement with a subsidiary of Royal Gold, Inc. generating net proceeds of US\\$162 million.
On Oct. 7, 2015, Teck announced that it and a subsidiary entered into a long-term streaming agreement with a subsidiary of Franco-Nevada Corporation linked to production at the Antamina mine. According to the announcement, Franco-Nevada will make an upfront payment of US\\$610 million to Teck and will pay 5% of the spot price at the time of delivery for each ounce of silver delivered under the agreement.
As of Dec. 31, 2014, scheduled debt maturities over the next five years are C\\$419 million in 2015, C\\$7 million in 2016, C\\$701 million in 2017, C\\$584 million in 2018 and C\\$583 million in 2019. Fitch expects the 2015 maturity to be repaid and 2017 maturities to be refinanced.
Fitch expects operating EBITDA to be about C\\$2.1 billion in 2015 and negative FCF generation of as much as C\\$1 billion in 2015 after C\\$2.3 billion in capital expenditures and C\\$345 million in dividends.
Fitch expects FCF to be negative in 2016 and 2017 despite the cut in semi-annual dividends per share from C\\$0.45 to C\\$0.15 announced in April 2015. Fitch expects that the company will continue to fund its share of Fort Hills and delay much of the other discretionary capital spending while the price environment is weak.
Absent material recovery in commodity prices, Fitch anticipates asset sales, additional cuts to the dividend or additional borrowings will be required to fund Fort Hills by 2017. Fitch would not expect material reduction of debt in advance of 2019.
FULL LIST OF RATING ACTIONS
--Issuer Default Rating (IDR) downgraded to 'BB+' from 'BBB-';
--Senior unsecured credit facilities downgraded to 'BB+' from 'BBB-' and assigned a Recovery Rating of 'RR4';
--Senior unsecured notes downgraded to 'BB+' from 'BBB-' and assigned a Recovery Rating of 'RR4'.
The Rating Outlook remains Negative.