XOM - Imperial Oil Stock Remains Undervalued

2023-06-27 12:24:47 ET

Summary

• Imperial Oil Limited is 70% owned by Exxon Mobil Corporation, providing a strong backstop on its valuation, as it's a potential acquisition target.
• The company had a blockbuster year in 2022, with its valuation of less than $30 billion, and it has continued to steadily invest in share repurchases.
• We expect Imperial Oil to continue its policy of driving shareholder returns, making it a valuable long-term investment.

Imperial Oil Limited ( IMO ) is a Canadian petroleum company, with a market capitalization of just under $28 billion, majority owned (70%) by Exxon Mobil Corporation ( XOM ). The company has focused on aggressively reducing its outstanding shares, generating strong free cash flow ("FCF") from its assets, making the company a valuable long-term investment.

Imperial Oil Financial Performance

Imperial Oil had record financial performance in 2022, with $7.3 billion in earnings and $10.5 billion in CFFO.

That's incredibly strong for a company with a market capitalization of less than $30 billion. The company managed to provide $0.9 billion in dividends, a 3% dividend yield, and $6.4 billion on share buybacks. That means the company took advantage of its single year of strong financial earnings to repurchase 14% of shares outstanding.

Lower oil prices means lower cash flow, but we expect the company to continue aggressively repurchasing shares and driving returns.

Imperial Oil Accomplishments

At the same time, the company's strong year is paired with a number of other impressive accomplishments.

The company has continued to ramp down lost time incidents while ramping up production. Kearl had its best ever 2H of the year production, Cold Lake had 5 consecutive quarters above 140 thousand barrels a day, and Syncrude hit the highest production in its history. At the same time, the company's upstream has paired with strong integrated results.

The company has had record refinery utilization and distillate production. It's worked to build additional renewable diesel facilities and it's recently completed new pipelines. These accomplishments better position the company to take advantage of higher prices in the market.

Imperial Oil Financial Performance

The company's financial performance will continue going forward. Imperial Oil is unique among other companies its size with a strong integrated portfolio.

The company's 2022 net income was actually stronger in its downstream operations versus its upstream operations, despite high prices. The company earned $3.6 billion in upstream net income and $3.8 billion in downstream net income. The company has continued to work on both its portfolio and utilization.

The company remains heavily resilient to low prices with this integrated model, and continues to invest strategically.

Imperial Oil Capital Spending

The company's capital spending, which it can comfortably afford, is not just sustaining capital but also growth capital.

The company has managed to improve its finances by reducing its sustaining capital. From 2023-2027, the company's sustaining capital is expected to be roughly $1 billion. That's a double-digit reduction from 2022. The company has ramped up growth capital past its prior outlook and is now spending more than $500 million on annual growth capital.

The company's 2023 target is based on an acceleration of prior programs along with increased renewable diesel. The company's sustaining capital is a mere $0.5 / barrel. That combined with growth is a level that the company can comfortably afford and it shows how cash that's not going directly to shareholder returns is still helping the company.

Imperial Oil Shareholder Returns

The company has the ability to continue generating strong shareholder returns as it improves its shares outstanding.

The company is almost a major in its own right with a yield of more than 3% and 28 years of consecutive dividend increases. The great thing about the company though is that rapid share reductions enable increased dividends at the same cost. Repurchasing 14% of its shares last year enables a 14% higher dividend at no cost.

More so, the company remains efficient and wealthy. Even in 2021 it generated more than $3 billion in shareholder cash distributions a double-digit yield. The company generated strong results in 1Q 2023, with a 14% dividend increase to $2 annualized (>4%) and $5 billion in annualized net income for the company.

Continued strong net income means strong returns.

Thesis Risk

The largest risk to the company in our view is crude oil prices. The company is profitable now with Brent crude prices at more than $70 / barrel. However, should prices drop down, that story changes. That could hurt the company's ability to generate additional FCF and future returns and make it a poor investment.

Conclusion

Imperial Oil might have a market capitalization of less than $30 billion, but the company is a strong integrated producer. In the Canadian market that's historically had a shortage of takeaway capacity, and struggles with pricing, the company's positioning has remained strong. That has enabled the company to generate higher FCF than its peers.

The company acts much like its big brother Exxon Mobil, which has a 70% stake. It's continuously grown dividends, and last year, managed to repurchase 14% of shares outstanding. We expect it to continue generating strong earnings, enabling it to both repurchase shares and pay dividends, making it a valuable investment.

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