By Wesley Blight, CFA, CIM, FCSI
Portfolio Manager, Fixed Income
I’d love to tell you a story about how we bought Teck Resources (TSX: TECK.B) in January 2016 when it hit a low of $3.80, and sold it in November 2016 when it reached a high of $35.02—a rise of 822%!
But that would be pure fantasy.
Owning Teck Resources has indeed contributed to the outperformance of one of our portfolios—the Canadian Equity Segregated Portfolio. But the fact is, we have been systematically reducing our exposure to Teck over the past three years.
To understand why, you need to understand Teck and our approach to value investing.
Met coal demand: It's all about China
Teck Resources Limited, as it’s known today, is an amalgamation of Teck and Cominco in 2001. (Cominco was founded in 1906 and Teck in 1913.) It is the largest diversified mining company in Canada, whose products include metallurgical coal, copper, zinc, lead, silver and gold.
The stock has been historically volatile and is highly susceptible to the strength or weakness of its main underlying commodity price: metallurgical coal (“met coal” or “coking coal”). Met coal has all the impurities burned out of it and is used to produce coke—the primary source of carbon in steel production.
And when you think about the demand for steel, what comes to mind? China, of course.
Met coal prices are pretty much dictated by the demand/supply dynamics from China and regardless of the company’s financials, those dynamics can cause huge swings in Teck’s stock price. On a smaller scale, the stock is also affected by the uncertainty surrounding the North American free-trade agreement.
Why we reduced our weighting in Teck
Teck has been a long-time holding in our Canadian Equity Segregated Portfolio, which is sub-advised by the Mackenzie All Cap Value Team. Mackenzie makes target recommendations which I review, approve and implement with our team at MD.
Note that the Canadian Equity Segregated Portfolio is a mandate, not a product. It is a portfolio of individual stocks that we buy for clients in our discretionary arm, MD Private Investment Counsel.
Specific to Teck, our clients would have seen their allocation to the stock decline over five separate occasions between August 2014 and October 2016.
Compared to the broad Canadian benchmark index, we had a significant overweight target position in Teck—approximately 3% to 3.5% of our portfolio versus 0.75% to 1%.
Here’s a timeline of what happened.
August 2014: We reduced the target weight from 3% to 2.75% when the shares were trading around $25. The global met coal market—50% of Teck’s business—continued to be oversupplied and its stock price started to decline.
Teck Resources: Five-year stock price history
June 2015: We trimmed our target weighting further from 2.75% to 1.75%. By this time, shares had fallen to $14 as a result of lower Chinese steel demand. We didn’t expect the share price to improve in the immediate future, but longer term, we saw value given the company’s asset base.
January 13, 2016: Teck’s stock fell to a low of $3.80—but then it went on a tear. As a result of product restrictions and supply issues in China, met coal prices were surging and contributed to Teck’s dramatic price rally.
April 2016: When the stock was trading around $12, we cut our target weight again—from 1.75% to 1.25%. The weak prices for met coal over the past few years had led to downgrades in Teck’s debt ratings and dividend cuts and we considered it prudent to take some profits and use the proceeds to buy other stocks.
September/October 2016: We reduced our target weight (1.25% to 1%) in September and once more in October (1% to 0.5%). We believed the events in the market were transitory and the stock would continue to experience heightened volatility.
In the Canadian Equity Segregated Portfolio, our patience was rewarded as we participated in Teck’s massive rise in 2016 and successfully reduced our exposure prior to its decline this year. The portfolio has outperformed the S&P/TSX Capped Composite Index and our decisions for Teck were a key contributor.
Despite the fact that it is highly volatile, Teck continues to play a role in providing diversity in our portfolio. As an example of our long-term value investing approach, it shows that we’re willing to be wrong for a period of time and recognize value when others may not. Thanks to this patient style of investing, our Canadian Equity Segregated Portfolio has outperformed its benchmark index over the long run.