If Petrobras Keeps Its Promises, Investors Will Be Rewarded Handsomely

Dec. 8.11 | About: Petrobras - (PBR)

By Mark Bern, CPA CFA

Petroleo Brasileiro SA (NYSE:PBR), better known as Petrobras, is a Brazilian integrated oil company with most of its operations in South America. The company was originally wholly-owned by the Brazilian government until its IPO in 2000. The most compelling opportunities for PBR lie deep below the surface of the Atlantic Ocean. The company has discovered two huge fields with an estimated 15 billion barrels of oil that it is preparing to tap into over the coming decade.

The company’s capital expansion plan is very aggressive with roughly $45 billion committed per year through 2015. Total long-term debt currently stands at about 28 percent of capital but that will have to rise to meet its capital spending projections. Lots of equipment is being brought in to drill and develop its prize fields in the pre-salt region off the coast of Brazil.

At $28.16 (at the market close on Tuesday, December 7, 2011) the stock price is well below its 52-week high of $42.75 and may represent an enticing entry point for investors with a little more risk tolerance than I have. But the potential average total annual return could be as high as 25 percent beginning sometime in the 2013-2015 period. This is a large integrated oil company that is acting very much like a wild cat outfit, betting all its marbles on being successful on one or two major plays. If the company does not make any major missteps the stock could easily run up to $75 within the next five years. And there would be more room to run after that as well as the fields’ output increases each year for several years.

The current dividend is a juicy 4.6 percent. And the dividend could easily rise by an average of 20 percent per year once production from the new fields comes on line. The yield will probably remain relatively steady as earnings would also rise at double digit rates. But Petrobras is not new to success. Earnings per share have risen by an average annual rate of 18 percent over the past 5 years and 23 percent over the last 10 years. But putting the dividend and prospective earnings growth aside for a moment we need to focus on the one thing that either makes it all happen or does not. The key to success is can the company drill successfully in deep water without a major accident. If that answer turns out to be yes, investors will be very happy indeed. A no would leave investors holding the bag.

As always, make sure you dig into this or any stock that you hear about and do your own investigation to determine if a stock is right for your portfolio.

Disclosure: I am long COP, OXY.