Despite the ongoing fallout from the European sovereign debt crisis and concerns about the slowness of the global economic recovery, the demand for oil proved to be resilient through 2011. It is predicted that this demand will improve in 2012 and escalate significantly in the foreseeable future. This can be attributed to supplies being constrained and ongoing political tensions and upheavals in major oil producing countries, notably in the Middle-East. Overall the oil price outlook for 2012 bodes well for oil producers, with Goldman Sachs at the end of 2011 predicting that the oil price per barrel will rally as high as $120 for Brent crude by July 2012.
However, the price of Brent Crude has already exceeded that target and is now trading at around $127 a barrel. This solid rise in oil prices bodes well for continued rises in the price of oil and for earnings and income growth for those companies involved in the oil production and exploration industries. When this is considered in conjunction with some of the increasingly positive signs of improvement in the U.S. economy and increasing demand for energy from China and India, the price should continue to rise. Together with increasing positive Latin American growth signs and in particular Colombia, I believe it is time to consider investing in resource companies that operate in Latin America. Ecopetrol (EC), Colombia's largest company recently reported its best financial full year results yet and I believe that it is a solid investment opportunity that will reward investors who invest now. In this article I will show you why. Ecopetrol is also Colombia's only vertically integrated oil and natural gas company that is geographically diversified with operations in Colombia, Brazil, Peru and the U.S. Gulf Coast.
Ecopetrol's 2011 financial results were particularly strong. For the fourth quarter 2011; the company saw a 14% rise in earnings to $9.6 billion and a 5% rise in net income to $2.3 billion. In addition, for this period its balance sheet strengthened with cash and cash equivalents rising a massive 53% to $3.4 billion, although long-term debt also rose but only by a marginal 2.2% to $4.1 billion. In line with Ecopetrol's solid fourth quarter 2011 financial results, it reported a particularly strong result for the final year 2011, with a net profit of $7.8 billion, which is an 85% increase from its net profit for 2010. This is the third consecutive year that Ecopetrol's net income has risen.
There were also a number of other key positive take outs from Ecopetrol's 2011 report, including:
- Net oil and gas production for 2011 rose by 15.6%, on a year over year basis, as a result of the higher production and transportation capacity of the Castilla and Magdalena crude wells.
- The opening of a new export market with the shipment of six million barrels of crude to Asia in 2011, as well as increasing diversification of export destinations with crude exports to other non-traditional destinations, such as the Caribbean and the West Coast of the U.S.
- A higher demand for natural gas predominantly from Venezuela.
- The company announced a 27% increase in reserves of 400 million barrels, giving the company reserves of 1.9 billion barrels.
- Ecopetrol announced plans to further increase reserves through the exploration of 42 new wells, with 37 located in Colombia, 3 in the Gulf of Mexico and 2 in Brazil.
The president of Ecopetrol also recently stated; "Ecopetrol is now producing 724,000 barrels a day and aims to lift this figure during 2012 to a daily average of 800,000 barrels, with aspirations of producing the equivalent of a million barrels a day by 2015 and 1.3 million barrels by 2020." All of this bodes well for further revenue and net income growth, as the company takes advantage of the expected increase in the price of oil through 2012.
There were however some negatives in the report that need to be considered, including:
- The cost of sales in 2011 increased by 38% from 2010 driven by a net increase of 45% in variable costs.
- For 2011 heavy crude production represented 48.8% of total crude oil production compared to 43.7% the previous year, yet light crude is more valuable and receives the highest price.
When investing in a Colombian company it is also important to consider the degree of sovereign risk especially given Colombia's history of violence and political instability. However, the security situation has improved considerably since the mid 2000s, leading to increased economic growth, foreign investment and prosperity. All of which has seen Colombia's economy expand at its fastest pace since 2006, with third quarter 2011 GDP growth of 1.7%, which in annual terms is 7.7% and the highest seen since 1979.
Overall despite ongoing low intensity conflict in some of the richest oil areas of the country, predominantly in the south eastern departments, the overall economic growth prospects are particularly bright and the degree of sovereign risk is lower than would normally be expected. In addition, Colombia is the fourth biggest oil producer in Latin America and total production in 2011 reached 914,000 barrels per day on average.
When comparing Ecopetrol's key performance indicators against its competitors the company appears to be an even more appealing investment as the table below shows.
Debt to Equity Ratio
Nexen Inc (NXY)
Petroleo Brasileiro (PBR)
Exxon Mobil (XOM)
Based on the PEG ratio, Ecopetrol has solid growth prospects, which are similar to Nexen's but far better than Petroleo Brasileiro's and Exxon's. I also quite like Ecopetrol's solid profit margin which is higher than Nexen's, Petroleo Brasileiro's and Exxon's, which when combined with a solid return on equity of over 30% bodes well for future earnings and income growth. Ecopetrol also has quite a conservative balance sheet with a debt to equity ratio of only 0.20, which is less than half of Nexen's and Petroleo Brasileiro's but double Exxon's.
This conservative debt to equity ratio bodes well for the degree of investment risk undertaken when investing in Ecopetrol, as it means its operations are predominantly funded by equity rather than debt. This means either an increase in interest rates or a drop in revenue due to a declining oil price should have little effect on Ecopetrol, nor should the company experience any discomfort with regard to debt covenants should its stock price drop substantially.
Overall the high profit margin and return on equity bode exceptionally well for future net income growth, however investors should remember that these are lagging indicators and do not necessarily provide a reliable prediction of the company's future performance. To get a good feel for Ecopetrol's future performance it is important to get a feel for its forward valuation and determine whether this is expensive in comparison to its competitors.
With a current trading price of around $61 and analysts' forecasts of 2012 EPS of $4.53, Ecopetrol has a forward PE of 13. Analysts are also expecting Ecopetrol's 2012 revenues to rise by 9% to $34 billion. Nexen is trading at around $20, with analysts predicting 2012 EPS of $1.93, giving it a forward PE of 10. Furthermore analysts have predicted a 3% increase in 2012 revenues to $6.5 billion. For Petroleo Brasileiro, one of Brazil's largest integrated oil and gas companies, analysts have estimated 2012 EPS of $3.11, which with a current trading price of around $28, gives it a forward PE of 9. Analysts have also estimated a 5% increase in revenues to $152 billion. Finally we have the king of oil Exxon, which is currently trading at around $87, with analysts estimating 2012 EPS of $8.19, giving Exxon a forward PE of 11. Analysts have also estimated that Exxon's 2012 revenue will drop by 3% to $473 billion.
Overall Ecopetrol does look expensive in comparison to Nexen, Petroleo Brasileiro and Exxon based on its current stock price and forward PE. However, based on its solid performance indicators and solid estimated revenue growth, which is substantially higher than Nexen's, Petroleo Brasileiro's and Exxon's I believe that it is justified.
I also quite like Ecopetrol's handy dividend yield of around 4%, which is a solid yield for an oil and gas producer and is equal to Petroleo Brasileiro’s 4%, double Exxon's 2%, and quadruple Nexen's 1%. Finally, I believe at its current trading price Ecopetrol is undervalued by the market with an earnings yield of 6%, which is more than double the current risk free rate.
Overall Ecopetrol is in good financial shape and year on year is consistently generating solid revenues and net income. Despite some other oil or natural gas plays appearing to have some stronger performance indicators and not being as expensive, I do not believe they have the same upside of Ecopetrol. I am of the firm opinion that Ecopetrol is well positioned to continue growing in value and investors who take a position in the company now will benefit from both strong growth and enjoy the solid dividend yield.