When times are rough in an industry, the big boys come along and buy up the little guys. Consolidation is a part of the business. And we’re starting to see this with Suncor looking to acquire Canadian Oil Sands. Another company that could be making acquisitions is Imperial Oil Limited (TSX:IMO)(NYSE:IMO).
There are a few reasons that Imperial Oil would make acquisitions. When oil prices were high, companies big and small were able to generate significant revenue. Even the little guys were generating profits, allowing them to invest in new projects that management hoped would result in significant growth in the future.
However, when times get bad, these same projects become a burden on the balance sheet. The money that management borrowed to pay for these projects suddenly becomes unpayable. This weighs the companies down, profits disappear, and suddenly they are unable to operate these otherwise amazing assets that they own.
One company that I believe Imperial Oil might acquire is MEG Energy Corp. (TSX:MEG). This is a small company that fits the above description perfectly. When oil prices were high, the company had ambitious projects in mind. Further, its assets at Christina Lake are tremendously efficient, which allowed the company to generate profit when times were good. However, MEG needed oil prices to stay high and, unfortunately, that wasn’t the case.
Now MEG has debt payments to make without the $100+ a barrel oil to help with those payments. Further, MEG didn’t have any hedged contracts in place to help it out. When a company hedges its oil, it gets contracts for the future at the present price. Therefore, a company that signed a hedged contract two years ago might have oil selling for $80 a barrel. That’s less than the peak, but it is far more than what oil is selling for right now.
Unlike MEG Energy Corp., Imperial Oil has the war chest needed to make an acquisition and integrate the business. Imperial Oil can handle lower oil prices for much longer than one of the small firms, so it is in a prime position to acquire MEG Energy. However, that’s not the only company. There are plenty of small oil firms that Imperial Oil and other large oil companies could acquire. I anticipate that next year could bring many acquisitions.
How to play this
There are two ways to play this. The first is a safer investment. Buying Imperial Oil because it is investing in its future is a smart move. Investors will send shares down because the company is bringing on more debt, but acquisitions can often times be exactly what the company needs to grow even more when oil prices return.
The other way to play it is much riskier: you could to buy MEG Energy Corp. or other small, attractive targets for acquisition. I would wait a few days to buy, though. Investors have sent the stock up in anticipation of an acquisition, but I doubt Imperial Oil will make an offer this week. Investors will get bored and sell their shares; that’s when you start acquiring.
I recommend sticking to Imperial Oil, but if you don’t mind risk, you could acquire shares of MEG and other small oil companies that are suffering. They might very well be acquired.