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Imperial Oil Limited (IMO - Snapshot Report) became a Zacks #1 Rank (Strong Buy) on November 30 after announcing its intention to acquire a 50% stake in an unconventional oil and gas producer. The company also reported an impressive third quarter earnings surprise in early November. With a forward P/E of just 10.2, Canada’s second-largest energy company looks like a solid value pick with earnings that are expected to continue rising.

Record Downstream Earnings Drives Strong Q3

Imperial Oil reported third quarter earnings per share of $1.22 on November 1, beating the Zacks Consensus Estimate by 20% and last year’s performance by 21%. Revenues of C$8.3 billion were up 5% year over year from C$7.9 billion.

Results were driven by record downstream (oil refining and retailing) profits, which nearly doubled year over year to C$536 million on the back of high refining margins. This more than made up for the slight decline in its upstream segment net income.

Proposed Celtic Stake Buy to Help Diversify Resource Base

On November 28, Imperial Oil agreed to acquire a 50% stake in Celtic Exploration Ltd., following the latter’s proposed buyout by Exxon Mobil Corporation (XOM). Imperial Oil, which itself is majority owned by XOM, is ready to shell out C$1.55 billion for a half interest in the Calgary-based liquids-rich unconventional natural gas producer.

The transaction – waiting regulatory and shareholder approval – will allow Imperial Oil to get hold of promising oil and gas properties in the Montney shale, Duvernay shale and other regions of Alberta. In particular, with the Celtic stake buy, the company will be able to complement its predominantly crude-oil-focused portfolio with attractive natural gas liquids acreage.

Solid Earnings Momentum

Following the third quarter earnings beat, the Zacks Consensus Estimate for 2012 is up 17% to $4.18 in the past 60 days. Given the $3.75 per share earned in 2011, the projected growth rate stands at 11% for 2012.

Valuation Picture

In addition to trading around 10.2 times forward estimates (a 14% discount to the peer group average of 11.9x), Imperial Oil has a price-to-book (P/B) ratio of 2.3, which suggests that the stock is still undervalued. (A P/E below 15.0 and a P/B ratio under 3.0 generally indicate value.) Additionally, the company sports a trailing 12-month return on equity (ROE) of 24.8% – significantly above the 15.3% that similar firms offer. This speaks to Imperial Oil’s efficient management that has consistently maintained a solid balance sheet with zero net debt.

Market Performance & Technicals

Below one can see the long-term earnings trend for Imperial Oil. In particular, the widening gap between the stock price and the earnings estimates for 2012 and 2013 indicate that Imperial Oil is currently undervalued.

Founded in 1880, Imperial Oil is engaged in the exploration and development of crude oil and natural gas resources in Canada. The Calgary-headquartered company enjoys a dominant position in several Canadian oil sands projects that include Cold Lake, Kearl, and Athabasca. Imperial Oil engages in three business segments: Upstream, Downstream, and Chemical.

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