If I was stuck on a deserted island with only one stock in my portfolio, it would be Petrobras (PBR). This much maligned stock has suffered disproportionately compared to other large integrated oil stocks recently and is down 18% since April 4th.
Troubles for Brazil’s state-owned oil company began last year when investors, discouraged over Petrobras’ large stock offering and interrelated purchase of drilling and production rights from the Brazilian government, pulled back on their holdings.
As a result, Petrobras has not participated in the huge oil price rally of the past six months and trails Exxon’s (XOM) share price gains by 44% over the past year.
Heightened concerns recently about the Brazilian government’s heavy-handedness have scared investors who fear that the government is undermining the free market system in Brazil to the detriment of Petrobras and other state-owned public companies. In April, Brazil’s Finance Minister, Guido Mantega, stated that Petrobras would not raise gasoline prices in Brazil despite the steep run-up in oil prices – a move intended to dampen inflationary pressures in that country.
In that same month, Brazil fired the CEO of its large, state-owned diversified mining company, Vale (VALE). These moves and others (including a public debate with management amid investor concerns over the cost of Petrobras’ long term capital plan), have created an environment of fear and loathing among investors towards the company.
Now, you are probably wondering, why would anyone in their right mind want to hold this stock? Let me outline my case:
- Petrobras is fairly valued on a current income basis but significantly undervalued on a forward basis.
- Petrobras’ state ownership is a net positive for the company and its investors in the long term.
- Current government policies in Brazil have understated Petrobras’ true earnings power.
- Petrobras’ home market – Brazil – provides significant advantages to investors, particularly those with high U.S. equity exposure.
- Petrobras is an excellent vehicle to participate in the continuing oil rally.
Petrobras is fairly valued on a current income basis but significantly undervalued on a forward looking basis. Sporting an EV/EBITDA ratio of 6.8 (TTM) and 5.9 (annualized Q1), Petrobras is slightly pricier than Exxon (6.5 TTM) and significantly more expensive than Chevron (CVX) (4.9 TTM). On a price-earnings ratio basis, the current consensus for Petrobras is $3.63 per share or a PE ratio of 9.4 versus Exxon (9.2) and Chevron (8.0). However, what sets Petrobras apart is its enormous production and reserve growth expectations.
Oil guru, Kurt Wulff of McDep LLC, writes in his May 17, 2011 report (pdf),
Offering an expected doubling of oil production by 2020, buy-recommended Petrobras (PBR)…discoveries offshore Brazil are the largest in the Western Hemisphere in several decades. Since the doubling will take time and money to achieve, we discount its eventual value to 28% of estimated Net Present Value of $62 a share. Yet, at a McDep Ratio of 0.59, investors may not be paying much if anything for that growth and at the same time less than present value for the businesses currently generating cash flow…Among emerging market and other large cap recommendations, Petrobras stock looks more than competitive by McDep Ratio.
(Note: McDep Ratio = Market cap and debt to present value of oil and gas and other businesses. Estimated present value presumes a long-term price for oil of US$100 a barrel and natural gas, $8 a million btu.)
Petrobras’ recorded oil and gas reserves understate the true potential of this oil behemoth that is expected to eclipse Exxon by 2020. The company recently projected a near tripling of its current oil production within the next nine years. At an event in Rio last month, company CEO Jose Sergio Gabrielli told reporters that
By 2020, we should be producing close to six million barrels [a day] ... of oil, just oil.
Petrobras recently reported that its domestic production for the May 2011 was just over two million barrels of oil. Although reserve growth has kept well ahead of production, much of the company’s future production capacity is not shown in the company’s reserves. This is because the true scope and capacity of the finds has not been fully established. Yet, week after week Petrobras announces major new oil finds.
As reported by Reuters’ energy market analyst Robert Campbell last month,
The industry has spent the last five years applauding Brazil for significant technical achievements, not the least being the discovery of mammoth new oil fields deep below the salt layers beneath the floor of the Atlantic Ocean. The finds are so large that Brazil will supply more than a third of the increase in non-OPEC oil output over the next five years, according to the International Energy Agency. The IEA forecast this month Brazil will pump 3.09 million barrels per day (bpd) in 2016, up from 2.14 million bpd last year. More massive gains are expected later in the decade.
Disclosure: I am long PBR.
