Shares of Petrobras (PBR) have been hovering in the low $30s since a record-breaking $70 billion secondary offering in September. The proceeds of the offering are part of a broader plan in order to expropriate the vast sub-salt oil reserves discovered in 2007 that may hold up to 50 billion barrels of crude oil (Reuters).
In the deal that set the stage for the secondary offering, the Brazilian government increased its stake in the company, raising concerns from those who fear the potential for broader-scale state intervention in the country’s economy.
Concerns regarding the offering and the role of the state in the country have left Petrobras wallowing close to 52-week lows despite the market’s intense rally since the beginning of September, creating a great opportunity for patient long-term investors.
Why the Risks Are Overstated
Many worried about outgoing Brazilian President Luiz Inacio Lula da Silva (affectionately known as Lula) as a former communist turned pragmatic democrat. People questioned whether Lula would take the country down the same path as Latin American neighbor Hugo Chavez embarked on in Venezuela. Instead Lula has overseen the emergence and expansion of Brazil’s economy and role in global politics. Lula has used a blend of socially oriented policies and free market reforms in order to oversee one of the great success stories in developmental economics today.
The initial fears surrounding Lula’s past proved completely overblown and the same applies today with regard to the state’s role in Petrobras and the transition from Lula to his elected successor Dilma Rousseff. International capitalists will always be wary of anyone who formerly had close ties with global Marxism, but that disdain borne in ideology comes at the expense of prudent financial and policy analysis. All indications point to the continuity of the pragmatic policies adopted by Lula and all signs point to the resource-rich Brazilian economy continuing on the path to developed nation status.
Petrobras itself is an amazing success story where the private and public sectors have worked and benefited in tandem. Through the company, Brazil was able ensure that at least part of the ownership over their own resources remained within the nation’s borders. At the same time, the government ensured a role in maintaining a domestic stake in environmentally sound practices on oil extraction, all the while building equity in the domestic economy.
What Value Is There in Petrobras Right Now?
Because of the aforementioned concerns, there is a substantial margin of safety built into Petrobras shares right now. Even after the share dilution, the company is trading with a forward P/E ratio of 9 and the earnings upside catalysts are aplenty: the price of oil is rising, Brazil is one of the fastest growing and most vibrant economies in the world, and tapping into the sub-salt oil supplies should generate huge long terms gains.
The company pays shareholders a 5.25% dividend, which affords investors the benefit of time in waiting for the upside spark in equity value. Another perk of dividends is that they provide another level of support to a stock’s share price. So long as the fundamentals of the company don’t deteriorate (which is not a concern here with PBR) then people will buy the stock to generate yield on an investment at certain levels. The $30 level in PBR looks like a good confluence point for technical chartists and fundamental value investors alike. With Treasuries on all time frames yielding less than PBR shares, it’s a sensible investment proposition for people on the longer term horizon.
Next, let’s compare Petrobras to another global oil giant: Exxon Mobil (XOM). Exxon trades with a forward P/E just north of 10 and a dividend yield of 2.5%. This relative divergence comes despite the fact that Petrobras has grown much faster over the past five years, is located in a faster growing economy, and holds some of the world’s most sizeable untapped oil reserves. Growth in the past, present and future all favor Petrobras, yet the company trades with a lower forward P/E and much higher dividend yield than Exxon.
The Upside Catalysts
Secular trends aplenty collide in Petrobras. We have the global commodity bull, the dollar diversification/weakness theme, and emerging market exposure all wrapped up into one. Collectively, these super-themes will offer protection regardless of which way U.S. equities move in the short to medium terms. With emerging markets growing at a much faster pace than the developed world, there is increasing competition for a finite amount of global resources.
With the company’s untapped reserves, Petrobras has the ammunition to feed into that surging global demand at a health margin and in scalable quantities. Additionally, Petrobras has been active beyond the borders of Brazil and the confines of the oil sector. The company is investing heavily in biofuels (which is a huge market in Brazil) and has a presence in many countries around the world.
Plus there is the multiple expansion that deservedly should take place once the short-run political concerns ease and the long-term growth story reemerges. Taken together, the risk/reward scenario in Petrobras looks extremely attractive in today’s market.
Disclosure: Author long PBR