Company Profile             

Imperial Oil Limited (TSX: IMO) is a Calgary-based integrated oil company in Canada, primarily involved in the oil and gas fabrication, petroleum products refining and marketing and chemical business. It is Canada's leading marketers of fuels, lubricants, and a major producer of asphalt. Imperial Oil is the subsidiary of one the world's largest publicly traded oil and gas company, Exxon Mobil Corporation which holds ~68% ownership interest in IMO. Imperial Oil has three operating and reportable segments, namely Upstream, Downstream and Chemical.

Investment rationale

• Strong balance sheet with solid liquidity position: At the end of Q1FY20, the company has a cash balance of CAD 1.4 bn, which provide enough financial strength to the company to cover its debt obligations efficiently. Further, the Interest coverage ratio of the company stood at 22.6x, which implies the group’s EBITDA is 22.6 times its interest expenses. The group has a comparatively lower debt exposure as compared to its peer, the long-term debt to total capital ratio of the company stood at 16.8%, whereas the industry average long-term debt to total capital ratio stood at 32.8%. 

• Gradually lifting coronavirus restrictions are likely to benefit IMO: The company is an integrated oil company with interests in Upstream, Downstream and Mid-stream activities; however, IMO's majority of revenue comes from the downstream activities, which include refining of crude oil along with distribution and marketing of refined products. Therefore, stable crude oil prices and improve demand offtake of crude oil is expected to benefit IMO. Further, gradually lifting of coronavirus restrictions are also set to drive oil demand which was largely muted since last two months. 

• A recent recovery in oil prices would also extend support: As the company has operational interests in the upstream activities, the recent recovery in the oil prices since April 21, 2020, is also expected to benefit IMO. Oil price recovered sharply after hitting a multiyear low in the April 2020 and easing lockdown restrictions across the world after approximately 2 months of stringent restriction on travel and economic activities, also bringing back oil demand in the market. Also, a series of production cut announced by OPEC+ cartel is further supporting oil prices in the international markets. 

• MACD is indicating a potential upside from the current level: On the daily price chart, shares of IMO witnessed a decent recovery from a multiyear low of CAD 10.27 recorded on March 18, 2020. However, the recovery was of a mix of ups and downs, but at the time of writing as on June 04, 2020 (after the market close), IMO shares have traded 1.95% higher at CAD 23.52, which implies a strong recovery 129% from the March 18 low of CAD 10.27. Further, the Moving Average Convergence Divergence, a momentum indicator that shows the relationship between two moving averages of underlying security prices is rising and hovering above the 9-day signal line, with the difference between 12-day Exponential Moving Average and 26-day Exponential Moving Average is positive, a bullish trend which implies that shares of IMO is likely to climb up further from the current trading level. 

• An Income Play with consistent dividend payment track record: The company has a consistent dividend payment track record over the last few decades. Further, despite an ongoing challenge in the oil industry, the company declared an interim cash dividend of CAD 0.22 for the second quarter of FY20, broadly in line with first-quarter FY20 dividend of CAD 0.22. The dividend has gone ex on June 3, 2020, and payment is scheduled on July 4, 2020. Also, over the past five financial years, IMO's dividend per share has increased by 9.5%. And, at the last traded price of CAD 23.52, its shares were offering a dividend yield of 3.7%, which is approximately 6.8 time of the Canada 10 Year Benchmark Bond Yield is at 0.54%. However, the yield has built upon the recent sharp price correction in the IMO stock price.

Financial Highlights: Q1FY20

During Q1FY20, significantly lower global demand had a material impact on crude oil prices, which, in turn, impacted the group’s financial results. The combination of demand reductions brought on by the COVID-19 pandemic and the supply glut resulting from the OPEC+ actions was truly unprecedented and resulted in a challenging business environment by the time the quarter ended.

In response to these conditions, the company announced reductions in 2020 capital and operating expense spending plans. The company has reduced capital spending outlook by CAD 500 million to CAD 1.1 billion to CAD 1.2 billion for the full year 2020. The group also announced that it would be targeting to reduce the operating expenses by CAD 500 million in FY20. Also, the company has suspended share buyback plans to preserve the liquidity amid challenging times.

During Q1FY20, the company reported a net loss of CAD 188 million or CAD 0.25 per share on a diluted basis compared to net income of CAD 293 million or CAD 0.38 per share in the same period of 2019. The decline in net profit was primarily driven by a noncash charge of CAD 301 million. Due to a significant decline in commodity prices at the end of March, inventory revaluation resulted in a loss of CAD 281 million, while remaining CAD 20 million noncash charges were associated with a goodwill impairment. The group generated cashflow of CAD 423 million from operating activities in the first quarter, compared to CAD 1,003 million in the previous corresponding period. Cash flow was impacted by lower realizations and unfavourable working capital impacts.

Upstream segment hit hard by the challenging environment and recorded a net loss of CAD 608 million compared to net income of CAD 58 million in Q1FY19. The decline in profit was on account of inventory revaluation, which resulted in a noncash loss of CAD 229 million along with a lower crude oil realization.

The downstream segment recorded a net income of CAD 402 million, up from CAD 257 million in the previous corresponding period. The improved performance was attributable to higher margins which contributed ~CAD 190 billion to the net income increase, which was partially offset by lower sales volume and noncash charges.

Chemicals segment recorded a net income of CAD 21 million in the first quarter, up CAD 23 million from a loss of CAD 2 million in 1QFY19 as margins and volumes increased.

Further, despite a challenging period, the board has declared a dividend of CAD 0.22 per share, an increase of 15% from CAD 0.19 per share in the first quarter of 2019.

Source: Company filings

Stock Price Performance

1-year price chart (as on June 04^th, 2020, after the market close). Source: Thomson Reuters

At the last closing price of CAD 23.52 as on June 4, 2020, its shares traded approximately 1.9% higher against the previous closing price. In a year over the period, its shares have registered a 52w High of CAD 37.75 as on June 20, 2019, and a 52w Low of CAD 10.27 as on March 18, 2020. At the last traded price, the share was trading approximately 36% below its 52w high price level and 129.2% above its 5w low price level.

Further, the group’s shares are posing a price return of 6.14% over a month period and relatively outperformed the benchmark index in the same time, and in the past five trading sessions IMO shares are featuring a price return of 6.47% and relatively outperformed the benchmark index by 4.6%.

However, on a YoY basis, its shares are still delivering a negative price return of 34.28% and traded 32% lower on a YTD basis as well.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 84.52% of the total shareholding. Exxon Mobil Corp and Artisan Partners Limited Partnership hold the maximum interests in the company at 68.76% and 4.1%, respectively.

Valuation Methodology (Illustrative): EV to Sales Based Relative Valuation

Stock Recommendation

During the Q1FY20, significantly lower global demand had a material impact on crude oil prices, which, in turn, impacted the company's reported financial results. However, its downstream segment had strong results during the quarter and recorded a net income of CAD 402 million compared to CAD 257 million in Q1FY19. The company has taken a number of steps to cope up against the turmoil and focusing on preserving liquidity. The group has reduced its capital spending by CAD 500 million and likely to spend in the range of CAD 1.1 billion to CAD 1.2 billion in 2020. The group is focusing on operational efficiencies and targeting to save CAD 500 million by reducing the operating expense. Also, the company has suspended the share buyback plan to preserve the liquidity amid challenging times. The group has a solid balance sheet with a decent cash balance of CAD 1.4 billion with a long term debt to capital ratio of 16.8%

Further, the shares of the company reported a decent reversal trend on the daily price chart, and at the last closing price of CAD 23.52 as on June 4, 2020, IMO shares were trading well above its crucial short-term support level of 50-day and 30-day SMAs, which reflects an uptrend momentum in the stock. MACD is also suggesting a potential upside in the stock as a difference between 12-day, and 26-day exponential moving averages are positive, which is a bullish trend.

Therefore, based on the above rationale and valuation done using the above methodology, we have given a "Buy" recommendation on the IMO's stocks at the closing price of CAD 23.52 (as on June 04, 2020), with lower double-digit upside potential, based on peer's Average EV/Sales multiple of 1.1x on the FY20E Sales. For the said purpose we have considered Cenovus Energy Inc (TSX: CVE), Husky Energy Inc (TSX: HSE) and Suncor Energy Inc (TSX: SU) etc., as a peer group.

*Note: All forecasted numbers have been taken from Thomson Reuters.

* Recommendation is valid on 5 June 2020 price as well.

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