To The Moon

Summary

• Imperial Oil is a large diversified Canadian heavy oil producer.
• The valuations are attractive but we rate it a hold at present prices.
• A dip toward $40 USD would put it in the buy zone.
• All prices in CAD unless noted.

Phototreat

Introduction

Imperial Oil (NYSE:IMO) is a Canadian heavy oil producer with upstream and downstream operations. Demand for the low gravity oil it produces has boosted revenues and profits over the last couple of years. Recently there has been weakness across the board in oil names, thanks to a 25% pull back in WTI and Brent has had the same effect on IMO, and this presents an opportunity to buy this company at a discounted valuation.

Price chart for IMO (Seeking Alpha)

It also is taking steps toward entering the low carbon fuels business with alarge investmentnear its Strathcona refinery. As the linked press release notes the company plans to produce a billion liters of renewable diesel annually, and avoid some three million tons of CO2.

Analysts rate thecompany a holdas it is trading near itsmedian price forecast of $57.43 CAD. The low estimate is $41.22 CAD and the upper end of the range is $71.69 CAD.

The company released earnings last week, beating EPS estimates by $0.25 CAD, and missing on revenue by $2.85 bn CAD. In this article we will review the earnings report and determine a suitable entry point for IMO.

The thesis for Imperial Oil

IMO is a large vertically integrated oil company with upstream, downstream-refining, and marketing operations. It that respect it resembles what many traditional American oil companies, Exxon Mobil (XOM), and Chevron (CVX) look like, just on a smaller scale. It is worth noting that XOM owns 69% of Imperial Oil.

In 2022 the company sold itsMontney/Duvernay shale assetsunder the XTO Energy Canada banner, to Whitecap Resources (OTCPK:SPGYF) for $1.9 bn CAD, to focus on its core oil sands business.

IMO has heavy oil operations at Kearl, Cold Lake, and owns a 25% stake in a Suncor (SU) managed JV in Syncrude that upgrades heavy, bituminous crude to light, sweet 32 gravity oil. Its total daily production from these sources in 2022 came to 441K BOEPD as they exited the year. One of the attractive features of oil sands production is its long life, low decline nature. Over time this reduces capital outlays to maintain production. In its 2022 Investor presentation the company notes costs declining below $20 CAD per barrel. The company is holding volumes constant at about 280K BOEPD at Kearl, and has plans for modest, single digit growth at Cold Lake and Syncrude. IMO has upstream development potential at a number of sites-Aspen, Corner, Clarke Creek, and Clyde where its heavy oil technology ERBT can be leveraged. The company also employspeer-leading technologyto reduce the carbon intensity of its daily output.

Refining is also a very successful business for IMO that supports its company owned service stations. IMO notes about 2,000 company owned service stations across Canada, doing business under the old ESSO and Mobil brands.

Petrochemicals is also a big business for IMO. At their Sarnia chemical plant IMO manufactures a number of chemical intermediates-ethylene, polyethylene, naphtha intermediates, and vinyl intermediates. These are used in a number of finished product applications as shown below.

Uses for IMO chemicals (IMO)

In addition to the planned new renewable diesel refinery, IMO participates in the Pathways carbon capture alliance. It will use H2 renewable feedstock captured at the source by the companies carbon capture and storage operations.

Layout of RD project (IMO)

A catalyst for IMO

The bio-diesel project could be a catalyst to boost the shares higher when it comes on line in 2025, subject to regulatory approvals.Bio-diesel delivers similar performance to petro dieseland a number of companies are converting old refineries to bio-diesel. Diesel sells at a substantial premium to gasoline, and when thetax incentives for low carbon fuelsare applied the total return will be very compelling. The Strathcona RD project is scheduled for startup in 2024, and expand into full operation in 2025. Imperial noted in aBloomberg articlethat it expected "double-digit" returns from this project.

IMO RD project in Strathcona (IMO)

As I have discussed in the past, biodiesel is one of the few renewable energy forms that make sense to me and has a clear pathway to profitable operations.

IMO Financials for Q-4, 2022 (CAD unless noted)

On revenues of $14,453 bn, Imperial reported estimated net income in the fourth quarter of $1,727 million and cash flow from operating activities of $2,797 million, compared to net income of $2,031 million and cash flow from operating activities of $3,089 million in the third quarter of 2022. Cash flows from operating activities excluding working capital of $2,452 million, up from $1,648 million in the same period of 2021. Fourth quarter results reflected strong operating performance across all business segments and robust diesel crack spreads, which were offset by lower upstream realizations. Full-year estimated net income was $7,340 million with cash flow from operating activities of $10,482 million. Long term debt in USD stands at $2.4 bn and cash on the books stands at $2.6 bn USD.

During the quarter, Imperial returned $2,145 million to shareholders, through dividend payments-$1.12 USD, accelerated completion of the company's annual normal course issuer bid program and successful completion of the company's $1.5 billion substantial issuer bid program in December. Throughout 2022, the company returned over $7 billion to its shareholders.

Lower bitumen realizations were primarily driven by the widening WTI/WCS spread. Average bitumen realizations decreased by $5.68 per barrel generally in line with WCS, and synthetic crude oil realizations increased by $22.68 per barrel.

Price realizations for IMO (IMO)

Risks

The biggest short term risk for IMO other than oil price fluctuations is the WTI/WCS spread. Currently in the low $20's, further deterioration would adversely affect IMO. The CME forward spread shows thisimproving as the yearwears on.

Longer term the company faces risk from Latin American sources of heavy crude. Chevron has gained a license from U.S. regulators to ship Orinoco grades to the U.S. and has already started doing so. CVX is one of the big Gulf Coast refiners, so this could impact Canadian producers.

Pipeline disruptions have the potential to disrupt revenue and have occurred with some frequency in recent times.

Another risk that should be kept in mind is the renewable outlays that involve new, and untested technology in some cases. We have seen in others where technological hiccups, or permitting delays cause costs to ramp higher than estimated.

Your takeaway

IMO has a solid business that is well diversified across in the industrial and retail sectors. Historically this has been a winning combination. The company is trading at discount to recent valuation thanks to the selloff in the oil market over the last couple of months. For reference larger competitors Canadian Natural Resources (CNQ), Suncor are down as well.

Price action last 5-days (Seeking Alpha/chart by author)

IMO is trading at attractive multiples on a cashflow and flowing barrel basis. EV/OCF on a run rate basis comes to 3.1X, and P/FB is $72 per barrel.

Investors looking for growth and income may want to consider putting IMO on their list for an entry point. The stock has traded into the low $40's in the past few months, and weakness in Q-1, 2023 could take it there again. A dip toward $40 USD should be considered a buying opportunity. I think the analyst position is on target at present prices and, as always, patience is suggested when the market is as frothy as it is now.

$Imperial(IMO)$

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