The countdown is on for Teck Resources Ltd. TECK-B-L to answer a crucial question: Why should investors want to directly own a separate coal division that pays the vast majority of its cash flow back to Teck?
The Canadian miner has debated spinning out the business for years, and management has considered many options, including talks with coal giant Glencore PLC and Lundin Mining, The Globe and Mail has reported. Yet every avenue led to a dead end, because no one seemed to want the highly profitable but out-of-favour coal business.
Ultimately, Teck settled on an unusual structure. Under the terms announced Tuesday, Teck shareholders will receive one share in a newly created, publicly listed coal business called Elk Valley Resources, plus some cash, for every 10 Teck shares they already own. If approved in a shareholder vote in April, the independent business will own and operate Teck’s existing metallurgical coal mines, which produce coal for steelmaking.
However, the business won’t be all that separate. Under the spinout terms, Elk Valley will pay 90 per cent of its cash flow to Teck for an estimated 11 years, based on coal-price projections, leaving its shareholders with very little. These payments have been called a “transition capital structure,” and they will be sent quarterly.
Teck Resources to spin off coal business, end Keevil family control
At the outset, that may not be problematic, because Elk Valley shareholders will also be Teck shareholders. Technically, they will be paying themselves. But anyone looking to unload their Elk Valley shares may face trouble doing so, because prospective buyers won’t be entitled to much cash flow for quite some time.
There are also questions about investor appetite for high-carbon pure plays, such as Elk Valley. Pension funds and asset managers, for instance, spend so much of their time explaining to beneficiaries and fund holders how they are reducing climate-related financial risks and aligning their strategies with net-zero goals.
To date, Teck’s investors could rationalize the miner’s exposure to metallurgical coal – which generated 60 per cent of revenue in fiscal 2022 – because it was complementary to the company’s copper and zinc production. Both metals are necessary for energy transition.
“That all kind of made sense within the diversified miner’s portfolio,” said Jamie Bonham, director of corporate engagement at NEI Investments, which specializes in environmental, social and governance (ESG) investing.
A pure play on coal is a much different scenario, however. “There are just a lot of investors that have very explicit rules around coal at the moment, and if it was a challenge owning Teck because of [it], then it’s going to be a lot harder to own Elk Valley Resources,” he said.
Teck isn’t the only commodity producer in this bind. France’s TotalEnergies is considering spinning out its oil sands interests through a dividend to its shareholders, and the independent company will have stakes in two projects, Fort Hills and Surmont, with an estimated value between $2-billion and $3-billion. It is unclear how receptive the company’s European-based investors will be to owning the assets in a standalone company, given the continent’s laser focus on ESG factors in investing.
For Teck itself, however, the current terms of the spinout could be quite advantageous – something Canaccord Genuity analyst Dalton Baretto referred to as a “have-your-cake-and-eat-it-too type situation” in a note to clients.
The miner has been looking to unload its coal assets for years, because coal is viewed as a “dirty” commodity. No matter how many times Teck explained that its coal assets are predominately used for steelmaking and not power generation, the latter of which is much more carbon intensive, investors did not seem to differentiate.
In turn, the coal business has weighed on Teck’s share price. And its enterprise value – a measure of debt and equity – is 4.4 times its 2023 expected earnings before interest, taxes and depreciation. Teck’s second major asset is copper, and pure-play copper producers trade at an average of 7.7 times, according to Royal Bank of Canada research.
The goal, then, has been to get the assets off Teck’s balance sheet, hoping the shares would float higher.
But it is possible that investors will question the shuffle. Because Teck is retaining so much cash flow from the coal business, investors may not re-rate the company – that is, treat it more like a copper producer. As RBC analyst Sam Crittenden put it in a research note to clients: “In the near term, the new Teck seems similar to the old Teck.”
Teck rejects this notion. “This is a true separation that will establish Teck Metals and EVR as standalone, publicly traded companies with independent management teams and boards of directors,” the company said in a statement.
“This separation will enable both businesses to realize their full potentials while preserving access to capital for Teck Metals [the new name for the copper and zinc business] to fund its copper growth potential and providing a responsible pathway to full separation over time as the transition capital structure is paid.”
As for investor interest, Teck said Elk Valley “will be a very high-quality business with strong margins, great relationships with customers, an extremely strong outlook for supply to the steel industry, and strong equity value accretion potential as the transition capital structure is paid over time.”
Teck added that Elk Valley will have an attractive dividend, and one of its major customers, Nippon Steel, is investing in the business.