IPCO - International Petroleum Corporation

[Anglozurich]

IPCO is a spin from Lundin Petroleum in 2017. The company has 300MMboe of long-life 2P O&G assets with low finding costs per barrel. For anyone new to the sector, that is a fair amount of reserves. Its 17 years of life in fact. The company can be purchased at $630m (enterprise value) and in my opinion trades at a significant discount to intrinsic value, even under conservative oil price assumptions. The management team is very credible operationally. Some are ex-Lundin and have solid track records with a history of delivering value to shareholders. They are extremely cost conscious and have delivered low opex per barrel for IPCO so far. They are also good allocators. They do not overpay for reserves, they react quickly to low and high oil price environments by adjusting capex/production and they were buying in chunky blocks of stock pre-COVID. There were a couple of decent write ups on VIC at much higher prices.

 

I invested in April during the liquidation of energy stocks and then again in October and its a large position for me. Energy feels awkward to sit in at the moment. A recent collapse in fossil fuel demand due to a once in a century pandemic has intersected with a period of zero interest rates, which has in-turn fueled investor momentum (and in many cases mania) in technology companies that naturally have the lowest of carbon footprints. For many investors and journalists, this has induced flawed reinforcement bias to some extent. The negative howling from ESG investors may not be as loud when returns are no longer correlated with carbon emissions. Stepping back from the bias and the pot-smoking journalism students, hydrocarbons will be needed in the future. We have just experienced the largest capital expenditure cuts in history to develop those hydrocarbons. This will prevent oversupply to some extent.

 

One is not buying dreams of $100 oil here but rather long-life assets, low finding cost per barrel and solid capital allocation. One does not have to believe in a great deal to do 3x within a couple of years. IPCO ticks Bruce Greenwald's small, hated and obscure boxes. If you think oil demand is a rapidly melting ice cube in the short-term, there is nothing to see here.

 

I wondered if anyone else owns?

[Foreign Tuffett]

What was the rationale for spinning off a collection of such disparate assets? Onshore France (France!?), onshore Canada (conventional and SAGD heavy oil), and offshore Malaysia is such a strange mix. What is management's strategy going forward?

 

 

[Anglozurich]

Lundin wanted to ring-fence Norwegian-holdings and spin the non-core international assets into IPCO via a tax-free dividend. Quoting the corporate jargon.....“The vision and strategy of IPC’s management from the outset was to use the IPC platform to build an international upstream company focused on creating long term value for IPC’s shareholders, launched at a favourable time in the industry cycle to acquire and grow a significant resource base.”

 

Many big hitters behind Lundin Petroleum’s long history of success chose to join IPCO. The former CEO of Lundin, Ashley Heppenstall, joined as an IPCO board member.  The former CFO of Lundin Petroleum, Mike Nicholson, is IPCO's CEO. The former Treasurer of Lundin Petroleum, Christophe Nerguarian, joined as CFO. Other key executives who left Lundin Petroleum and joined IPCO at the time of the spin are Ryan Adair, IPCO’s VP of Reservoir Development, and Daniel Fitzgerald, IPCO’s VP of Operations. Management and the controlling shareholders have a significant interest in the company. The Lundin Family and management own 25% of the total shares. The Lundin family have not sold down any shares during the share repurchases and remain the largest shareholder.

 

I agree it is an eclectic geographic mix, but the optics are about as strange as it gets. The 2P reserves across the piece are simply high quality if you define quality as low breakeven costs per barrel and visible FCF being pumped back to headquarters. IPCO have used the FCF from Malaysia and France (two very profitable projects) to make acquisitions of high-quality assets in Canada at very cheap prices. The following transactions still look cheap even in a post-COVID oil price, which tends to mean companies are buying well:

 

1) The Suffield assets acquired in 2017 (75% gas, 25% oil) were neglected by the previous owner (Encana). IPCO’s management can sweat assets and they know how to operate complexity. They drilled 20-30 wells and have already generated significant FCF from Suffield. There is a lot of runway left for further development. The break-even price of gas production is between 0.2 and 1.6 CAD/mscf. c.20 for WCS. Higher than France and Malaysia of course.

 

2) In 2018 IPCO merged with another Lundin company - BlackPearl, a heavy Canadian crude operator. Yes, I was sceptical that IPCO was a dumping ground for badly behaved Lundin problem childs. They have proved me wrong. Black Pearl has proven its worth so far in terms of FCF and most of all optionality. Yes, its heavy crude but management seem to handle it by chipping and chipping at cost per barrel. Most of all they are patient and organised with capex and wait for the right oil price environment. The optionality is interesting. I would never bet the ranch on contingent resource, but they inherited 1 billion of 2C resource through Blackrod (Dec 2019 measurement). They will let oil prices rise a little and the pilot wells will start firing into Onion Lake and Mooney. Yes, 1 billion of 2C is worth something at a decent breakeven.

 

3) In January 2020, IPCO acquired Granite Oil, a Canadian listed oil company split-off from DeeThree in 2015. It seemed to be mismanaged in the past as FCF simply paid down debt and passed through as dividends without any capex for development. IPCO acquired Granite at very low price/2P reserves of 5.5 CAD per barrel! The oilfield has 200 million barrels of OIP. They are looking to apply their operating expertise to vastly improve the recovery rate. This cigar butt approach seems to be right in their sweet spot. 

 

IPCO is a collection of mostly long-life, low cost conventional fields with low decline rates and impressive Free-cash-Flow generation. Management are organised, experienced and patient with development under the right oil price conditions. They are intensely focused on FCF and are proven capital allocators i.e. buying cigar butts, breathing life into them and sweating the FCF. The stock trades at just over one third of the company’s net assets per share….not a lot has to go right 

 

(*yes France surprised me too. France isn't a great deal at 6% of production but the French fields have a great track record with low decline rates. The French government handed IPCO an interest free COVID relief loan). There is still a lot of 2C to explore. I believe they are switching their off-take agreement so its one to watch

 

 

[Foreign Tuffett]

Thanks for the response. It's an interesting idea, but the ~$328 million USD debt load makes it a pass for me. 

[Anglozurich]

Fair enough. the RBLs mature mid 2022 and 2024 respectively and they are not significant relative to FCF, assuming a slow recovery in the price of oil.

[Anglozurich]

This has worked very nicely for me. They generated FCF overall in 2020, and $50m of FCF in H2. In a year when the oil price went down the elevator shaft that is a very impressive performance. In 2021 they are focused on FCF,  less expansionary capex and focusing on de-levering instead of being overly aggressive in uncertain conditions. They always seem to retain optionality and take a view as prices and conditions change to the benefit of shareholders, which i love. That is very similar to Lundin and rare in the oil & gas space. 272 MMboe of 2P as at December 31, 2020. For those who do not look at the sector, its an enormous reserve base and management are delivering on sweating those assets.

 

I think this is a long runway and going higher.

[Anglozurich]

This stock is just not covered but a hidden gem. It is has been close to a 3 bagger for me over 12 months all while the Tesla thread is now on its 500th page.....

 

Can anybody poke holes in this thesis.

 

Per 2020 AR...

 

Firstly

 

"2P reserves as at December 31, 2020 of 272 MMboe, with a reserves life index (RLI) of 18 years. Contingent resources (best estimate, unrisked) as at December 31, 2020 of 1,102 MMboe"

 

This is just an enormous amount of 2P and 2C and thus reserve life.

 

Secondly

 

"2021 operating costs guidance at USD 14.6 per boe........Full year 2021 capital expenditure budget of USD 37 million, with a focus in 2021 on free cash flow

generation and debt reduction"

 

Low finding cost per barrel and management are consistently laser focused on capital allocation. Why you ask?!They are from the Lundin school, there is heavy insider ownership and therefore why wouldnt they be laser focused on capital allocation. I am very impressed with the team and their rational, calm approach to everything.

 

Based on third party reserves reports, the net present value (NPV)of IPC’s 2P reserves..............IPC’s net asset value (NAV) as at December 31, 2020 was USD 1,309 million.IPC’s NAV per share was USD 8.4 as at December 31, 2020

 

Someone pointed out debt as a risk. Thank you for the challenge but sorry, it is just not a risk. They have an asset base as at 31.12.2020 of $1.3billion and will have already blasted a hole in that net debt figure in 2021. At today's oil price, allbeit on an unhedged basis...

 

$52.00 (WSC)-14.6 (2021 op/bll per company guidance) *42,000 (2021 mid company guidance) less capex ($17m/365) = $1.5m per day.

 

Net debt was $321m at the year end. They can clear the debt within one year at today's price if they wanted to.

 

 

You are buying a reserve base that is being worked and sweated by a management team who are very shareholder friendly and smart. You are paying $500m USD in market cap for assets that will return billions of FCF to the shareholder over the next few years assuming a very modest oil price.

 

 

 

 

[Anglozurich]

Is anyone following this? Still no takers? Q1 FCF alone represented 10% of the company’s market cap. Buybacks could be as early as Q3 given the speed of deleveraging. This is still too cheap.

Edited May 6, 2021 by Anglozurich

[jefke]

I own a small position. No special insights from my part, I have nothing to add to what you already wrote here

https://twitter.com/hammerinvesting likes it and has been tweeting about it

[sbalsam]

I own a small position as well.

I agree with your high opinion of (i) management and (ii) the three Canadian asset acquisitions made over the last few years.  I also love management's boldness in using the Company's free cash flow to make large acquisitions and meaningful buybacks.

Again, this is going on memory from research done about 18 months ago, but I love seeing them take out companies/assets with minimal increases to G&A. G&A savings from acquisitions is something all companies talk about and rarely display while IPCO has been fantastic in this regard. IPCO comes in and buys very low when the target is unable (Granite and Blackperl) or unwilling (Suffield) to spend the money needed to optimize the project and then makes the deal look even cheaper when it pulls out meaningful amounts of G&A that the target had been spending.

Why, then, do I only own a little? Really, it was just bad timing on my part. I found and fell in love with the Company and bought a major position in late 2019/early 2020. As covid was rolling in, I felt that oil could be hammered and sold most of my position at break-even (no, I was not as smart with my other longer-term energy holdings). If I have one quibble it is that they are not the lowest cost operators and that hurt them (most everyone else too of course) in the first half of 2020. I have bought a little back in recent months and believe the company will do very well in the years ahead.

Steve    

[Anglozurich]

@sbalsam  I agree with your points. I will start with the only negative i can find......How did you feel about the 5m increase in PSU's to management? That p i ssed me off a little given the awards are linked to the SP and have been gifted at the bottom of the energy cycle. But i suppose Mike and his team brought across their own shares options in Lundin and have skin in the game. If they deliver big, they should be paid big so i whilst im not jumping out my shoes over the share units, its a fairly hefty award. 

Ok the positives - there are so many here. Buffett in an AGM - cant remember what year - stated that he would compensate management of an oil and gas company based on their finding costs per barrel - that should include acquisition cost, the geo, development cost, drilling, opex, maintenance, G&A, transportation - everything. How much has has each barrel cost them in total. I tried to work this back for IPCO and these guys are seriously impressive. Their capital allocation is just simply textbook. Watch the buybacks come and come heavy in H2. 

I was looking for an E&P company that could hoover up cigar butt type 2P and 2C resource at a cheap price in the hydrocarbon world, work the assets and then wait for the moment the 'woke society of investors' can no longer cancel the sector because a greater portion of the investor universe now realises that ermmmmmm we kinda need hydrocarbons for the foreseeable. The lack of investment / capex into new production will become a bigger concern over the next 5-10 years. We dont even have planes in the air internationally and india is on its knees and brent is still at $70........Anyway, i found IPCO. What an asset to own over the next 5-10 years. 

This is a significant position for me and given its a commodity business, i will  constantly monitor their finding cost per barrel and capital allocation but i can not fault it so far. Lundin were always great at capital allocation and its no wonder its showing up in IPCO given these guys went to school there. On turning over the 2C into 2P, I am very excited about Onion Lake also. I think the French assets are high quality and i think there will be upside in Malaysia. Do you think they will partner up with someone for Blackrod? 

We are talking 20-25% FCF yield for this asset EV/FCF.  Even if the WCS discount widens it is still ridiculously cheap

Edited May 14, 2021 by Anglozurich

[Anglozurich]

Funnily enough my question got picked by Becky Quick at CNBC regarding the oil and gas sector and it was asked at the Berkshire AGM this year....youtube link below 

 

[compounding]

One thing that de-risks this investment is that one of the major points of the previous bear thesis for companies like this (chasing growth at bad prices) not only disappears, but actually turns into a part of the bull thesis when and if supply gets restricted. Given that supply becomes constrained, owning that supply becomes a valuable advantage. 

Another way to conceptualize why this opportunity exists for someone like IPCO is that they are in the sweet spot for avoiding the institutional imperative currently affecting the industry. The international majors are pressured by activists into changing their business models, and few are resisting that pressure. IPCO is small enough to fly under the radar, but large enough, and skilled enough, to be able to capitalize in a major way. 

I think the largest risk owning something like this is misjudging the supply/demand-dynamics of the commodity. That risk is strongly mitigated at the moment by the valuation in relation to the cash flows they currently produce and the ability to secure hedges as long as that divergence exists and the oil price stays stable. 

[Anglozurich]

@compounding i agree its not wise to bury ones head in the sand with regards to 'the commodity cycle' and just plunge money it at a point in the cycle that has so obviously peaked. We are no where near that point. In fact we are at the start of a cycle where new/fresh projects and capacity have already been choked off for years. I am not betting on roaring oil prices with IPCO. This notion that all businesses within a commodity industry are the same, is a mistake investors constantly make. Progressive, Ryanair, Lundin Energy, Costco, high quality US regional banks  - they all sell commodity products but look at the charts over the long term and compare them with the industry average. They look very different. It means they are doing something different on the cost side, employing less capital and turning the capital over to give it back to shareholders

IPCO is the best 'value investor' in the E&P business i can find. Not only does it significantly reduce its finding cost per barrel by paying next to nothing for 2P, it has the operational expertise to sweat the assets with EOR capability and turns the spigots on and off quickly depending on the oil price. I think they will do buybacks in H2 and then depending on oil prices, they will start to unlock 2P from Blackrod with either a partner or FCF from the other cash producing projects. Management constantly signal they are willing to extract that value and give it back to shareholders. They are shareholders themselves and the Lundin family havent sold a share. Why wouldnt they allocate capital in the best possible way.

Are things getting better or worse for this company. 100% better. Yes the oil price is out of my control but investing is about expected probabilities. Do i expect brent to drop 50% any time soon. No i dont. 

Edited May 26, 2021 by Anglozurich

[compounding]

I mean, I agree with you. My entire post pointed out why IPCO is not an operator among many and mitigants to the oil price risk and the capital allocation risk. But comparing a low cost oil E&P-company to Progressive and Costco is brave, I'll give you that. 

It's great that you have conviction about the commodity price. I'm just pointing out that as a generalist, I think that the supply/demand-dynamics is one thing which will strongly influence the outcome that I could see myself being wrong about. 

I also agree with you that, given a stable oil price, IPCO will be able to create value. For reasons that you point out in your post and have highlighted throughout the thread. There is also optionality from the contingent resources or pipeline extensions reducing the WCS spread. 

[Anglozurich]

Agree. I overshot with Costco lol. Point being revenue per seat mile for short-haul european flights fluctuate...wildly...the airlines are price takers but ryanair over time has beaten its competition by not worrying about seat prices and controlling what it can control - costs, ancillary revenue and capital allocation

Having 'conviction over the oil price' is probably not the right characterisation. However, i do think the intersection of 1) irrational minds believing we no longer need hyrdocarbons due to intense ideologies over climate change (often driven by intense political ideologies, not facts)...combined with.... 2) a time when the world was using 15 million barrels of oil per day less than the norm due to the world stopping and sending the oil price falling through the elevator shaft..........has increased the probability of permanent changes to decisions on whether to deploy fresh capital expenditure for new exploration and production. In other words i am ascribing a greater probability to supply decreases over time versus the pre-covid situation......  

Edited May 27, 2021 by Anglozurich

[compounding]

16k stock purchase (worth SEK 623k at just under SEK 39/share) by William Lundin the other day. Obviously not significant in terms of his net worth, but it strikes me as something with signal value when family members (maybe especially when they are operational) start buying in their PA's when the family is already massively exposed. 

[Anglozurich]

https://www.international-petroleum.com/investors/presentations/

 

Page 52 of the June 2021 corporate presentation. Market cap is currently $700m. This is still a 66% discount to NAV based on end-of-2019 conservative oil price deck and WCS discount was wider. Brent now $74 and WCS $59. The company should be producing $250-300m USD of Free Cash Flow on a run-rate basis at todays price. They are quite rightly delevering but the buy-back gun is close to going off in H2. Management are loaded up on share units. Hold on to your seats.