The Surprising Reason Why Teck Resources Ltd. Slashed Its Dividend

Teck Resources Ltd (USA) isn't a name that brings to mind oil; but believe it or not, oil is one of the reasons why this miner just cut its dividend 66%. And despite falling oil prices, this burgeoning business segment is a bigger opportunity than it may at first appear.

A dominant trioWhen it comes to Teck Resources, coal, copper, and zinc rule the day. This trio accounted for virtually all of the top and bottom lines last year.

The price of coal and copper, however, fell year over year in the first quarter, resulting in this pair, which make up nearly 70% of sales and 60% of gross profit, materially detracting from performance. There was a little bit of positive news: The zinc business, which basically provides the rest of sales and gross profit, was up year over year.

Coal, a key business, and major first quarter detractor, for Teck. Source: Thomas Bresson, via Wikimedia Commons.

At the end of the day, however, ongoing weakness in coal and copper led to a nearly 40% decline in profit attributable to shareholders. This, in turn, precipitated a 66% dividend cut. The company explained: "This reduction brings our dividend payout and yield more in line with current commodity prices and outlook and ensures balance sheet strength and flexibility for future capital expenditures or other capital allocation opportunities." (Italics added.)

What does oil have to do with this?Oil didn't contribute to sales in the quarter, but the $243 million Canadian -- $200 million U.S. --that Teck spent in its oil segment was a notable drag on the bottom line. The miner will be spending another $600 million Canadian during the rest of the year, too, which is roughly $500 million in U.S. dollars. While weak coal and copper prices were the direct cause of Teck's top- and bottom-line woes, its future capital expenditures in the oil space was another less-obvious cause.

What exactly is going on in oil? Teck has a 20% interest in an oil sands mine with Suncor Energy (USA) and France's Total. The project, known as Fort Hills, is still being developed, with oil expected to start "flowing" in earnest in 2018. However, it costs a lot of money to build an oil sands mine from the ground up, even for expert miners like Teck and Suncor.

Canadian oil sands are mined like coal, copper, and zinc, not drilled and pumped like oil. Source: Paul Joseph, via Wikimedia Commons.

But this could be a pretty big opportunity, and will definitely help to diversify Teck's business. Teck's stake is worth around 36,000 barrels of oil a day. At current prices for Western Canadian Select oil -- around $56 Canadian and $46 U.S. -- that could mean something on the order of $700 million Canadian, or $600 million U.S., a year in revenue. This would put the oil business on par with its other three businesses on the top line today.

It's also worth noting that Suncor's cash operating expenses at its oil sands operations at the end of 2014 were around $35 per barrel Canadian, roughly $29 dollars U.S at recent exchange rates. Once Fort Hills is up and running, and all the capital spending is over, the oil operation would likely be profitable, even at today's relatively low oil prices.

A lot can happen between now and 2018; but spending on an oil project today should make Teck a much stronger company down the line. And while the dividend cut stings, long-term investors should appreciate that the current sacrifice is likely to be worth it when the oil starts flowing.

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Total (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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