June 24, 2014 - 6:45pm EST by
2014 2015
Price: 51.67 EPS $0.00 $0.00
Shares Out. (in M): 848 P/E 0.0x 0.0x
Market Cap (in $M): 43,795 P/FCF 0.0x 0.0x
Net Debt (in $M): 5,954 EBIT 0 0
TEV (in $M): 49,749 TEV/EBIT 0.0x 0.0x

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  • Oil and Gas
  • Canada


Imperial Oil (IMO) is Exxon’s ~$45 billion majority-owned Canadian subsidiary. Despite its size, Imperial attracts little attention; the company hosts no quarterly conference calls, rarely attends investor conferences, and provides scant financial disclosure beyond that required by regulators. Imperial boasts an impressive corporate history and has been in operation since 1880. Employing little leverage, the company has averaged a return on equity of ~30% over the last fifteen years (more than twice industry peers) while retiring half of its shares outstanding. Owing to cost overruns and delays on its most ambitious expansion project, Kearl Oil Sands, the share price languished and investor enthusiasm waned over the last five years.


Contrary to my experience with a variety of MLPs, Imperial does nothing to make its shares fashionable in the current market, focusing instead on making them more valuable. They pay a dividend of 1%—a fraction of peers'. They plan decades' worth of high return growth expenditures, yet investors currently prefer payout to reinvestment. They employ conservative financial reporting and do not utilize non-GAAP measures. Reported net income substantially understates long term earnings power.


Oil sands differ from traditional oil wells in that they require large upfront capital (Kearl will cost ~$31 billion), but once in production have no natural decline curve and produce for more than forty years. Outside of revenue linked to oil prices, oil sands bear more economic similarity to a manufacturing operation than a traditional E&P. In the case of Imperial, four years of investment in Kearl has generated ~$18 per share of unproductive assets on the balance sheet, relative to a price of ~$52 per share. Kearl began initial production in Q3 2013 though it will not turn cash flow positive until 2014. I believe the ramp-up of Kearl represented an undisclosed drag of more than $0.50 per share on 2013 reported EPS of $3.32. As this $18 per share of unproductive assets transitions to cash flow generation over the next few years, I believe the company will enjoy substantial growth in free cash flow.


By my figures, the company earns ~$5.50 per share if one gives credit for just the first two phases of Kearl (phase two is 72% complete and phase three carries the best economics), assumes strip oil pricing, and discounts the free cash flow back to today. I find the shares very inexpensive at <10x EPS and a 10% free cash flow yield, especially in light of a high caliber management team and a AAA credit rating.


The investment also carries a number of interesting options. First, my analysis assumes a 25% discount for Western Canada Select heavy crude oil. In the event that the Keystone pipeline is approved, I believe this discount could shrink to 10-15%, adding over $1.10 per share to earnings. Second, my earnings estimate gives no credit to a number of prospective assets that I value at $4 – 8 per share. Finally, Imperial recently received regulatory approval for an LNG export facility. While I do not know if the project will be pursued, based on the valuations for other LNG export facilities under construction opportunity could be quite valuable.


I would also like to highlight IMO’s management compensation plan since it is particularly interesting. The company faces a challenge given the long lead time associated with major projects that can single-handedly make or break the company’s economics. To answer this challenge, IMO employs long term incentive stock grants with very unusual vesting. For the CEO, 50% of his shares cliff vest after five years and the remaining 50% vest at the later of 10 years or retirement. In the company’s own words:


“The long vesting periods ensure that a substantial portion of the compensation received by the chairman, president and CEO, as well as other key executives, will be received subsequent to retirement. The value of this compensation is at risk in the event that their decisions as senior executives prior to retirement negatively impact share market value after retirement. The objective of these aforementioned vesting periods is to hold senior executives accountable for many years into the future, and even into retirement, for investment and operating decisions made today.

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.


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