Petroleo Brasileiro Offers Nice Upside Potential

Aug.28.14 | About: Petrobras - (PBR)


Despite the fact that Petrobras missed analysts’ estimates in the second quarter earnings report the company’s fundamentals are intact.

The company plans to invest $153.9 billion mainly to develop pre-salt and post-salt production during 2014-2018.

The company is positioned to produce 3.2 million barrels of oil per day by the end of 2018 and 4.0 billion of oil per day during 2020 to 2030.

Currently the Brazilian government has an approximate 54 percent stake in the company making it a state-sponsored monopoly without any real competition.

In the recently published article on, Mike Koza, a prominent investor, sees the company’s potential doubling in four years.

Petroleo Brasileiro S.A. (NYSE:PBR) is one of the largest companies in Latin America in terms of annual sales revenues. The company has been producing approximately 90 percent of Brazil's total oil production. During the second quarter of 2014, the company's total oil and gas production increased by 2 percent and increased from 2555 thousands of oil equivalents in the second quarter of 2013 to 2600 thousands oil equivalent barrels per day.

The increase in total production was primarily driven by the increased domestic E&P activity. The Brazilian production was recorded at 2383 MBOE/d reflecting an increase of 2.7 percent from the corresponding quarter in 2013. Despite increased production, the company failed to meet the earnings expectations primarily due to higher exploration costs. In addition, the fuel price was regulated by the government and that hinders the company from passing on the increasing costs.

However, the company's fundamental are still intact. Going forward, the company is targeting a production goal of 3.2 million barrels per day by the end of 2018. The target seems to be achievable as the company has been putting efforts into developing its pre-salt reserves. The company has taken concrete steps to exploit these reserves. During 2014-2018, the company plans to invest approximately $153.9 billion in different exploration and production projects mainly to develop the pre-salt and post-salt production. Currently, the pre-salt production constitutes approximately 22 percent of the company's total production. However, with the strategic allocation of capital budget, a robust increase in the pre-salt production is expected. The pre-salt production is estimated to constitute approximately 52 percent of the total production, 3.2 million barrels per day, by the end of 2018.

In addition to pre-salt reserves development, the company plans to acquire exploration rights in Brazil and abroad. The company seems to be determined to meet the production target of 4.0 million barrels of oil per day during 2020-2030. Moreover, the company has strategically planned its production and is planning to keep a reserve to production ratio of more than 12 years.

Is the Brazilian Government's Controlling Interest a Blessing or a Curse?

The future prospects of the company are deeply linked with the socio-economic and political dynamics of Brazil since the Brazilian government controls 54 percent of the company. Some analysts believe that the Brazilian government's controlling interest is a blessing. However, there are other analysts who tend to disagree and believe that it is the only factor that is hindering the company from unlocking its true potential. This is a debatable issue and both of these positions are supported by arguments and counter arguments that have their own pros and cons.

Despite the arguments given in favor of or against, it is a fact that the Brazilian government enjoys a controlling interest in the company. Therefore, the upcoming elections can be a major catalyst and will determine much of the company's future direction. At this point, I would like to refer to the recently published article on in which the contributor, Ken Kam, tried to explore the company's future prospects in wake of the developments on the political front. In an effort to identify the company's true potential, Ken Kam interviewed Mike Koza, the value investor with an investment style similar to Warren Buffett who has earned an annualized return of 17% over the last 10 years. Koza believes that Petrobras has been trading at a discount to its industry peers and has the potential to double within the next four years.

Final Words

To some extent, I agree with Mike Koza's analysis that the current P/B ratio of 0.74 makes the company a cheap investment when compared to the industry average of 1.45. In addition, Petrobras is currently trading at a forward P/E of just 7.97. Given the long-term growth prospects of the company, I believe that the company has been trading at a great discount and that sooner rather than later the stock price will be adjusted. Moreover, Petrobras is a state-sponsored monopoly with practically no competition. The company is taking tangible steps to ensure long-term production growth presenting ample upside potential.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.