If you watched Saturday night hockey games on TV in the 1960s, you’ll remember the commercials with always friendly ‘nice guy’ Esso dealer Murray Westgate assuring you that you could “always look to Imperial for the best”. Oil and gas securities analyst Tyler Reardon of Calgary-based Peters & Co. says that’s still true. But Mr. Reardon is thinking more about oil and gas stocks rather than products.
Headquartered in Calgary, Imperial Oil Limited (TSX─IMO; NYSEMKT─IMO) is one of the oldest and biggest big-cap Canadian oil and gas stocks, boasting exploration, production, refining, and a nationwide chain of service stations.
With its rigs drilling for oil off Nova Scotia, its refineries cooking up chemicals at Sarnia and its service stations dispensing gas from Newfoundland to British Columbia, all of Canada might seem fair game for Imperial Oil.
But northern Alberta — specifically, the tarsands — says the company, is now likely to offer the best opportunity for growth.
And Imperial is a big player in the tarsands, tipping the scales with 19 billion barrels of oil, of which 26 per cent, or five billion barrels, are in situ, says Mr. Reardon, who’s keeping the company pegged at “sector perform”. He’s also sticking with his 12-month price target of $48 a share. He notes:
Heavy crude oil expansion planned
Imperial is focusing on expanding its heavy oil operations at Aspen, Clyden, Corner and Grand Rapids, all of which are in northern Alberta and all of which would each have seven expansion phases. Each phase would see output increase by 55,000 to 75,000 barrels of oil a day.
Previously, the company had set out a nine-phase expansion, with production per phase pegged at 35,000-45,000 barrels a day.
In the meantime, Imperial is expecting to get regulatory approval for its Aspen operations, although it hasn’t yet made its final investment decision. Should Aspen pick up steam, it could post its first output in 2020, although, its completion, we believe, won’t occur until afterwards.
Historically, Imperial has pegged costs for these projects at $35,000 per flowing barrel. But with steam-assisted gravity technology, the cost, the company believes, could be cut to $25,000.
Once it’s ramped up its Nabiye project at Cold Lake, Alta., Imperial sees its output of oil and natural gas liquids hitting 410,000 barrels a day — a number that also hinges on its ramp-up of phase two of its operations at Kearl, Alta.
But because we’ve already pegged 2017 production at 400,000 barrels a day. We’ve made no big changes to our estimates.
Capital and cost budgets cut
For its part, the company believes that it was quicker than most of its peers to cut costs. For example, in January, Imperial sought voluntary cost reductions from its service providers. Indeed, in conducting reverse auctions for services at Kearl, the company believes it saved $100 million in voluntary concessions.
In total, Imperial now estimates that for 2015, it has trimmed $1 billion in both its capital and operating costs.
In the interim, this major Canadian oil producer still sees its top priorities as sustaining its capital, taking advantage of growth opportunities, buying back shares, as well as paying down its debt.
From now to 2020, Imperial expects to spend $2.5 billion a year on capital projects — $1 billion less than it predicted back in April 2014, as well as $3 billion less annually over the past four years. The reduction mainly reflects cost efficiencies, as well as a more limited set of opportunities.
Specifically, the cut in capital spending reflects the company’s soon-to-be-completed expansions at both Kearl and Nabiye.
But capital spending could rise over the next few years, given the pace of in situ development at Aspen and Clyden, as well as the green-lighting of liquefied natural gas (LNG) development in British Columbia, we believe.
And although Imperial provided no major detail about its capital spending in 2016, its budget for this year is expected to come in $100-$300 million lower than its initial forecast of $4 billion. So, we’ve cut our estimate of the company’s 2015 capital spending to $3.7 billion from $3.9 billion.
Capital maintenance requirements lowered
In the meantime, Imperial is pegging its capital maintenance requirements at $1.2 billion a year — $500 million less than what was previously expected.
The cut mainly reflects lower costs at Kearl for which the company is now pegging sustaining capital at $5-$10 billion. The reduction also reflects a cut in sustaining capital at Cold Lake to $3.5 billion from $5 billion.
And although we’ve folded these lower numbers into our model, our estimate — $1.6 billion — still tops the company’s forecast.
Despite this, we continue to see Imperial trading at an implied free cash flow yield of five per cent, among the highest of the big-cap oil and gas stocks.
Meanwhile, the company still sees its research and development costs ranging between $150 million and $200 million a year.
And when it comes to technological research, Imperial has been concentrating on steam-assisted gravity drainage, as well as on non-aqueous extraction. Now that it has pilot-tested its SAGD at Cold Lake, the technology is now ready for commercial use, says the company.
Liquefied natural gas (LNG) projects evaluated
Elsewhere, Imperial continues to evaluate the overall competitiveness of a large-scale project in liquefied natural gas with Exxon Mobil Corp. (NYSE─XOM). Although Imperial is still moving ahead here on all fronts, it’s nonetheless too early to gauge the attractiveness, timing and economics of a potential project.
Not only has the company raised its dividend each year for the past two decades, but it has ample room to keep doing so, we believe. For example, Imperial’s current annualized dividend would represent $475 million in 2016, which compares to our estimate of free cash flow of $1.8 billion.
All told, the company ranks well compared with many of the oil and gas exploration and production companies we now cover. For one thing, its underlying assets and operations are quite resilient. Moreover, it continues to generate free cash flow.
In addition, Imperial’s shares have outperformed those of many of its peers so far this year, thanks in part to the improvements it has made at Kearl. The outperformance also reflects the defensive nature of the company’s assets, as well as the profitability of its downstream business.
Investor’s Digest of Canada, MPL Communications Inc.
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