Teck Resources: The Message Was Loud And Clear

Teck Resources (NYSE:TCK) shareholders went on a wild ride last week as the company's stock climbed by nearly 10% on Monday following Bloomberg's report that the Vancouver, British Columbia based coal and copper producer has been exploring a mega-merger deal with its Chilean peer Antofagasta (OTCPK:ANFGY) to create one of the world's biggest copper company. The rumor was later denied by Teck Resources in a short statement, and the shares dropped by 10% the following day, wiping out all the prior gains.

Data source: IndexMundi.

For Teck which gets more than a quarter of its annual revenues from copper, however, the message was loud and clear. Shareholders want the company to take advantage of the weakness in copper prices, which touched their five-year lows in January, by engaging in accretive mergers and acquisitions. With improving copper demand and supply fundamentals, it wouldn't be surprising if Teck gives investors what they want.

The weakness in copper prices has been driven in large part by the sluggish demand growth from China, the biggest consumer of the metal. The country's property market, which drives around 30% to 50% of copper demand, has been struggling. But if China's housing sector recovers in the long-term, this could go a long-way in improving copper's fundamentals.

The Chinese regulators have taken several measures aimed at lifting housing sales. Although I believe these will have a limited impact, particularly in the short term, they will likely speed up the process of recovery. The slowdown in the property development activity from last year is going to give respite to the market. Meanwhile, the homebuyers are going to absorb the excess supply that came on the back of the 2013 property boom over the next couple of years. A decrease in supply coupled with the ease in regulations related to sale and purchase of property will fuel the recovery of the country's housing sector. An eventual uptake in the development activity should give a boost to copper demand.

It also helps that copper miners have been largely focusing on reducing their costs during the downturn, as opposed to spending capital to grow future production. Teck, as well as its peers, has delayed investments in some major copper projects. As per estimates from the International Copper Study Group, the copper market witnessed "lower than anticipated" production growth in 2015, due in part to project delays, as world mine production of the metal increased by just 3% last year. Teck, for instance, hasn't reported any meaningful growth in copper production since 2012, but has consistently lowered its costs. The rumored deal between Teck and Antofagasta could also have allowed the two companies to join forces and achieve additional cost savings, given Teck also has significant copper mining operations in Chile. Together, these actions (concentration on cost reduction and project delays) have not only improved copper miners' efficiency, but also could lead towards a shortage of supply in the future. Teck believes that a supply deficit could occur by 2017, which should have a positive impact on prices.

What does this mean for investors?

Copper producers have been struggling due the weak prices and Teck Resources is no exception. The company's shares might continue to struggle this year, with a possibility of a dividend cut following the May 28 board meeting. However, with an uptake in copper demand from China in the long-term, which could also coincide with a supply deficit, should push the metal's prices higher by 2017. To capitalize on higher future prices, Teck will likely remain on the prowl for M&A opportunities. In a research report emailed to me, Credit Suisse's analyst Ralph Profiti wrote that a "sweet spot" for a deal will be with a company that has producing assets in the 100,000 tpa range (attributable) located in low-risk jurisdictions (Americas) where Teck "can move 3rd/4th quartile mines down to the middle of the cost curve."

Investors with a bullish view on copper also need to keep an eye on Antofagasta, diversified miner Glencore (OTCPK:GLNCY) which has significant exposure to the metal, as well as copper pure plays First Quantum Minerals (OTCPK:FQVLF), Southern Copper (NYSE:SCCO) and Freeport-McMoRan (NYSE:FCX).