Friday, March 24, 2017

Imperial Oil - 22 Years of Dividend Growth

As I work my way down the Canadian Dividend All-Star list, I review certain companies that I would never consider purchasing due to my own lack of knowledge relating to their industry.  Such is the case for Imperial Oil ("Imperial"), an integrated oil and gas company with a 22 year history of dividend growth.


Company Overview

Headquartered in Calgary, Alberta, Imperial Oil was founded in 1880 and is a subsidiary of Exxon Mobil Corporation. Imperial explores for, produces, and sells crude oil and natural gas in Canada. The company reports on three business segments, namely upstream (25% of FY16 revenues), downstream (71% of FY16 revenues), and chemicals (4% of FY16 revenues). Many Canadians are familiar with the company's 1,700 Esso service stations throughout the country. 

Dividends

Imperial last increased their dividend by 7% in April of 2016. The company's stock currently yields about 1.5%. The dividend payout ratio is relatively modest at 24% of FY16 earnings. The 3, 5, and 10 year dividend growth rates are decent at 6.4%, 6.0%, and 6.3%. 
% annual average growth planned through 2021
Valuation
The current share price of ~$41 equates to a trailing P/E of 16X. This value is slightly high given the stock has traded in the 10-14X range for most of the past 5 years. Looking at EV/EBITA leads to a similar conclusion, with the company currently trading at 20X in contrast with their 5-year average in the 8-12X range.

Catalysts

There are a couple key reasons why you would consider adding Imperial Oil to your investment portfolio.

1. Financial Flexibility
With an AA+/Stable corporate credit rating, Imperial has a strong balance sheet which it has leveraged during the prolonged period of lower oil prices. An example of the financial flexibility afforded to the company is the 2016 sale of hundreds of Esso stations to operators in Canada that fetched the company ~$3B.
 2. Ownership by Exxon Mobil
Exxon Mobil Corporation owns 69.6% of Imperial’s common stock. The majority ownership by the powerful Exxon Mobil Corporation is seen as beneficial since Imperial can leverage Exxon’s management, technology, connections, and expertise in order to help their business prosper.   


I have a hard time classifying Imperial’s dependence on the price of oil as a catalyst or drawback. Although commodity businesses tend to scare me as companies have to be price takers in an environment where the price is out of their control, I can see the attractiveness of an integrated oil company like Imperial if you believe that the price of oil will rise. With only two public large cap, integrated oil companies in Canada (Imperial and Suncor), betting on the long-term rise in oil prices would be possible on either company, and you could even collect a dividend while you wait to see if your thesis proves correct. However, if your thesis proves false, the share price of Imperial is likely to fall in tandem with falling oil prices.  

Drawbacks

Beyond the paltry current dividend yield and their dependence on the price of oil, there are a couple of other issues to consider before adding Imperial to your portfolio.

1. Dependence on CAPEX for growth
Imperial has two options to grow their business. They can either conduct research and drilling to find new oil wells, or they can buy established wells from other companies. Both of those growth options are costly. Imperial went from spending $5.3B on CAPEX in 2014, to $3B in 2015, to a scant $1.1B in 2016 as oil prices fell. With management providing guidance of $1B of CAPEX in 2017, it would seem that Imperial is simply looking to maintain their position and not grow until the price of oil recovers.  In contrast, Suncor’s management has been investing by buying other businesses while the price of oil is low with an eye toward future growth.
2. Limited free cashflow to fund growth projects
The main reason that Imperial has cut CAPEX to a maintenance level over the past two years is that their cashflow from operations has decreased substantially from $4.4B in 2014 to $2.0B in 2016. Since the dividend requires funding of ~$500M and maintenance CAPEX is about $1B, there is currently little left to fund growth projects.


Conclusions

When reviewing the portfolios of other Canadian dividend bloggers, Imperial isn’t a name that comes up frequently. Some of the key reasons for its lack of popularity are the company’s reliance on the price of oil, the low current dividend yield, and uncertainty regarding future growth prospects. As might be apparent from above, I don’t foresee adding Imperial to my portfolio anytime soon and would be more likely to consider Suncor in the integrated oil and gas sector. 

Would you consider adding shares of  Imperial Oil to your portfolio?

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