AdShooter/E+ via Getty Images

AdShooter/E+ via Getty Images

Imperial Oil (NYSE:IMO ) is Exxon's Canadian mini-me. While Exxon is one of the world's largest integrated O&G companies, Imperial is Canada's main integrated O&G company. This is no coincidence as Exxon owns 70% of Imperial, and co-invested with imperial in its main asset, Kearl.

Although IMO is integrated and has profitable downstream assets in Canada, long term, its main value proposition comes from its stable, low depletion upstream production profile. Situated in a developed and mature regulatory environment, with capacity to serve the US market, its assets will remain critical for decades to come.

Despite the recent rally, we are only now reaching levels last seen a decade ago. Not much has happened for Canadian oil sands investors during the last decade.

However, things are looking a lot better now for Imperial. During the time frame in this chart Imperial completed Kearl, its major production asset, which sets it up with a multi-decade production platform and competitive cash break-even costs.

Free cash flow is the key reason for owning Imperial. I have owned it for a long time, and it looks like we long-time-suffering shareholders are about to get paid for our patience.

Production hit an all-time record in 2021, which is saying something because no major projects have come online since Kearl, its main production asset, was completed some eight years ago. Much of its production growth is due to smaller projects to improve (debottleneck) Kearl. Since then, and going forward, capex will remain minimal relative to cash flow. A bonanza for shareholders in this low debt enterprise.

Capex is forecast to remain stable, with most of the budget consumed by maintaining - rather than growth - capex. This means replacing equipment, not investing in growth. The reason IMO can do this is because its production profile, particularly at Kearl, has very low depletion rates. The nature of this oil sands project means you know exactly how much oil there is around. No worries about reservoir pressure, etc. Kearl, at $20s/Bbl in cash cost, will be able to produce for many decades to come, with minimal investment.

Compare the levels of Capex above (at CAD1.5Bln/$1.2Bln) with the free cash flow expected at selected WTI price level:

Free Cash Flow at Oil Prices (Investor Day 2022)

Free Cash Flow at Oil Prices (Investor Day 2022)

Free cash flow already deducts capex. The point is how much excess cash is being generated at all modelled WTI prices. At $80/BBl of WTI, free cash flow reaches CAD$6Bln ($4.8Bln). Already, WTI is above $100/Bbl, which is not modelled, but it is not unrealistic to expect over $5Bln in free cash flow for 2022.

The main risk with a cash gusher like this is that we don't get to control its destiny. Without any major projects under study, and none needed to maintain production at current levels, as stated above, management had been toying with the idea of a special dividend or a large share repurchase. They had already increased the dividend by a larger than usual amount, but cash continued piling on the balance sheet.

Finally, together with earnings released late in April, the company revealed its plan to repurchase and cancel CAD2.5Bln ($2Bln) worth of shares, roughly 6% of its current market cap. A rational, tax-sensitive move and I am all for it. But cash will continue to pile on! The dividend costs $0.6Bln so together with the share repurchase we will get $2.6Bln returned, or roughly 50% of free cash flow (at $80 WTI).

At the very least, if prices remain above or around $80/Bbl management will almost certainly maintain this level of buybacks, meaning a substantial year on year reduction in share count. At the same time, production will likely remain flat, and there is little debt to repay. This is not a new look for Imperial, by the way, let's look at some metrics of what it has done in the past decade.

Buffett noticed early on that Coca-Cola (KO) was going to be able to grow volumes at 2-3% for a very long time, while also growing prices and reducing its share count along the way. Over multi decade horizons, the compound effect of this small yearly efforts is hard for our linear-thinking minds to comprehend.

Imperial today is no Coke in the 80's. However, its low cash cost per barrel and its low depletion asset base means it will be able, in my view, to maintain constant production volumes while at the same time reduce its share count. It can do both for a very long time. If high oil prices are here to stay, it may be able to reduce its share count at a faster pace than it has historically.

Let's look at two moments in time, 2012 when Kearl was still under construction, and 2021:

To put these same numbers another way, Imperial managed to grow production 52% while reducing its share count by 21%. It did this without increasing debt in any meaningful way. Yet, the price of one share of stock is only back to where it was back then.

Imperial will not grow production again by 50% in the next ten years, as it did in the last decade. There is no Kearl-sized project in the pipeline, and part of the reason is precisely that: lack of pipelines. However, this need not be a bad thing, as cash will necessarily be diverted back to owners. As a result I expect share count will be reduced by significantly more than 21% in the next ten years. As stated, in 2022 alone the reduction is expected to be over 5% (with cash leftover after that).

Policy-wise, as the US continues to struggle to adequately incentivize oil infrastructure needed within its borders, long-lived and existing oil production just outside those borders will remain quite valuable. For Canada, its mining industry is at the heart of its economy. It may be one of the more favorable regulatory environment for oil production for years to come.

This story is a cash flow story. In US$, Imperial's market cap is $35Bln. This year, it is set to produce over $5Bln in free cash flow or 1/7 of its market value. It has no relevant debt, with net debt of only $2Bln, and no viable large expansion projects to throw money at. Kearl has +30 years of life at current production levels. Almost by default, cash flow will be directed at owners, in a very big way, and for a very long time. No complaints here.

This article was written by

Disclosure: I/we have a beneficial long position in the shares of IMO either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.