Imperial Oil Ltd (IMO)

In this week’s content analysis, we’ll take a closer look at the process behind one of last week’s transactions, as we performed our Canadian model portfolio rebalancing. The Energy sector weighting, as suggested by Market Trend, dropped to 9% in April from 13% last quarter. This indicated the need to cut one of our three Energy positions. Following further analysis of these holdings (Shawcor Ltd, Parkland Fuel Corp, Imperial Oil Ltd), we decided to sell Imperial Oil Ltd (IMO) Download .

At first look, Imperial Oil offers a respectable SPScore (62% as of April 6th, 2015), but a closer look reveals that its fundamentals have been declining quickly over the past several months (SPScore was 74% as of December 31st, 2014).

Since 2011, Imperial Oil’s NOPAT (net operating profit after tax) has consistently dropped while its capital charges have doubled. In other words, it appears that the additional focus on capital investment since 2011 has only served to decelerate the continued drop in NOPAT, when ideally these investments would serve to accelerate earnings growth. As a result of the above, return on capital (NOPAT/Capital) fell from 23.8% in 2011 to 9.9% in 2014, the lowest it’s been in five years.

We’ve also seen substantial movements in the company’s valuation metrics over the past 18 months. IMO’s Intrinsic Value has moved from $80 in September 2013 (P/IV of 0.6) down to $49.56 today (P/IV of 1.04), indicating a slight overvaluation. Future growth value (FGV) is at around 40% as of April 6th, 2015, and represents a premium which we consider high given short term growth prospects in the sector. You’ll note that the premium shown by FGV has also increased continually over the past six quarters, all while Imperial’s current operating value (COV) has been decreasing. This shows an increase in short term risk as the proportion of the price of the stock supported by the company’s COV is smaller and smaller.

As for economic performance, EVA has been trending down since March 2012, and its Q4 2014 was the first negative-EVA quarter in five years. This movement in EVA is one of the principal factors motivating our decision to sell Imperial Oil. Despite the fact that neither of the other two Energy holdings (PKI, SCL) are offering much more attractive trends, their EVA remains positive, which allows them much more manoeuvring room to re-establish stability or even growth.