By Joseph Hogue, CFA
Hopes earlier this year that the Brazilian government would allow gasoline prices to increase and stop losses by the refinery unit of Petrobras (PBR) have not worked out for investors. Bloomberg reports that Latin America's second largest oil and gas company is losing a record $8 billion this year by selling imported gasoline below cost.
Weak refinery capacity led the company to increase imports by 65% in the third quarter. Mandates on the price of gasoline mean the company must sell these imports into the market at 8% less than cost, increasing losses 75% from $4.8 billion to about $8.4 billion.
The government is using its control of prices to slow the pace of inflation, which has exceeded the 4.5% target since September 2010. Demand for energy has been trending upward as the country digs itself out of an economic slowdown. The economy is expected to grow by 4% next year compared to just 1.5% this year. If the government does not allow gas prices to increase, the pickup in growth could significantly detract from revenue at Petrobras.
Investors in the company's ADR shares could also get hit if the local currency weakens further against the dollar. As the currency weakens, assets held in the country will be worth less when converted to dollars. Local shares have fallen only 8.9% over the last 12 months, but weakness in the real have caused U.S. investors to see a 23% loss on the ADR shares.
Do not expect too much pity for investors on the part of the government. The state owns a majority control of the company and uses the profits to fund its social programs.
Shares of Petrobras have underperformed the iShares MSCI Brazil ETF (EWZ) by 16% this year. While the general economy may rebound next year, future growth at the company could be compromised by the need for asset sales and restructuring to meet capital spending. The shares trade for 13.5 times trailing earnings, just below 14 times for the country fund, and pay a 1.3% dividend yield.
Investors looking for exposure to LatAm energy may want to look at Colombian producer Ecopetrol (EC). The company replaced Petrobras this year as the largest explorer in the region and trades at an only marginally more expensive 14.1 times trailing earnings. The shares have jumped 31% this year, outperforming the Brazilian competitor by 60% since January.