CA - International Petroleum: Growth Project Underway

2023-12-13 07:44:16 ET

Summary

• International Petroleum is part of the Lundin Group of companies, which gives it access to resources available to the whole group.
• The company expects to produce $700 million to $1.4 billion in free cash flow over the next five years.
• The appreciation potential for the company's stock results from a sizable growth project and the return to more historical valuation levels.
• Ferguson offers substantial upside potential if the rather large reserves can be produced at competitive costs.
• The overseas business is steady and produces needed cash flow for other projects.

International Petroleum (IPCFF) is part of the Lundin Group of companies. This gives it access to resources available to the whole group rather than just the organization itself. On the homepage of the Lundin Group of companies, William Lundin, Chief Operating Officer, details how the company expects to produce $700 million to $1.4 billion in free cash flow over the next five years. The high number represents a roughly 25% return annually at the time of the presentation. It is a little lower now but still impressive.

This company grows by a combination of acquisitions and organic growth. It has so far been a relatively rapidly growing company. That is likely to continue. Most of the business is in Canada. But there is some business in France and Malaysia as well.

Ever since the spinoff from Lundin Energy company back in 2017, this company has managed to grow both cash flow and income significantly. Despite this growth, the stock price has not kept pace from the original starting price near $4.

What has happened instead is that throughout the industry, price-earnings ratios collapsed. While those ratios are busy returning to closer to average historical valuation, there is still some appreciation potential left.

The company also has a major project underway to increase thermal oil production. That likely means there is still more appreciation potential in the future.

Blackrod is one of the places that International Petroleum produces heavy oil or thermal oil. Therefore, the upfront costs to begin production are on the high side. But once that initial hurdle is met, these projects often cash flow generously even if the project loses money. The initial costs provide a generous depreciation component.

Once the project is up and running, oftentimes there are many projects that can bring costs down to very reasonable levels with a lower breakeven than the initial breakeven to get the project started.

International Petroleum produces a lot of discounted products in the production mix as a result. It is diversified in that it also produces light oil and natural gas. This helps the cash flow tremendously during cyclical downturns.

The company does keep a strong balance sheet so that if production has to be shut-in, then the company can do that without suffering major financial stress.

Suffield Assets

Offsetting the thermal and heavy oil production would be the Suffield Assets which produce both oil and gas. This is a conventional opportunity without all the costs associated with the thermal oil production. There is a fair amount of secondary recovery by using water injection. So, the assets have a fairly low decline rate. Production costs, however, can run higher than what investors think of as the usual conventional business.

Canada Future Upside

Long-time readers may remember the Ferguson leases when the company acquired Granite Oil. This is a lighter oil project that has a lot of reserves if a way can be found to produce those reserves at a reasonable cost. Should that happen, this project offers tremendous upside not priced into the stock.

So far, this project has minimally contributed to the overall company production. But if the recent spurt of production proves profitable enough, that could be the beginning of a growth spurt for a potentially extremely profitable business.

This was another water injection project that appeared to be on the cheap side. While Granite Oil had no problems reporting a fantastic amount of reserves, getting those reserves out of the ground proved to be another matter entirely.

As you can see from above, this management has likewise been working on that project. Just because companies report reserves, does not always mean they can produce them at a reasonable cost. That is why production is steady as shown above until management resolves that production cost issue. From the latest production growth, management may have taken that step to bring this big field online. Time will tell.

Overseas

The company has steady businesses in both France and Malaysia. Neither business appears to be "going anywhere" in the near future. Both businesses are dependable cash flow generators. Though both are relatively small production contributors to overall production.

Finances

Management generally keeps debt at a conservative level. The largest production is discounted products to light oil sales prices. Therefore, there is a danger of the discount of the products sold from this production, widening to a level that demands production be shut-in until prices recover.

This management understands that with such a product line, the balance sheet needs to be unusually strong. Management also has a diversified production stream. There are products that will likely sell throughout the business cycle to provide sufficient cash flow.

This management will hedge as appropriate to minimize the volatile cash flow swings. That helps. But what would help more would be the growth of light oil and condensate production.

Key Points

International Petroleum is growing fairly quickly. The original oil production provides a fairly strong cash flow. But, for all the market emphasis on free cash flow, the thermal group of producers (in particular) seems to lag when it comes to market recognition. This could be due to the heavy losses the group runs during downturns.

For five years, from 2015-2020, not a single Canadian producer I followed reported significant heavy oil or thermal oil profits. Pricing is now far better than it was back then. But overall profitability takes darn good cost control.

Production costs for the heavy oil and thermal producers is coming down as it is for much of the industry. There is every chance that the Blackrod expansion could well come in under budget because of operational improvements sweeping the industry as the initial construction phase advances. That should result in more profitability than originally budgeted.

As a Lundin Group company, this company has access to the group resources. The Lundin Group has an excellent corporate reputation. This company probably deserves a look by investors that understand the much more volatile business cycle of heavy oil and thermal oil (as well as secondary production). The company is a higher risk proposal due to the higher costs of production.

But that higher risk is compensated by the resources of the whole Lundin Group. Still, this stock has to be regarded as speculative. The story here is growth. Therefore, income investors can look elsewhere.

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