Investors of Petroleo Brasileiro Petrobras (PBR) have had a strenuous year. The stock price has fallen 14% this year and the erratic dividend has left many investors in a very uncertain situation. With a stock that has fallen nearly 60% in the past 3 years and a dividend yield which is almost as volatile, many investors have thrown in the towel and cashed out of their shares. Through this report, I present the case that PBR could potentially bottom in the near future and investors should prepare to purchase shares once again.
Margins are Key
The first item we will examine in this report is profit margin. Profit margin is a figure which calculates profit as a percentage of revenues that the firm is able to keep after expenses. The figure is very handy in that it is normalized - or calculated so that it can be easily compared to history. A firm with high profit margins is one which is able to defend its competitive edge significantly. If a firm is able to defend itself from competitors, then it will incur high expenses associated from attempting to outmatch its opposition. As the firm enjoys higher profit margins, these margins can be paid out to investors as dividends or invested back into the firm for further expansion and growth. The chart below shows the historic profit margin of PBR.
As can clearly be seen in the chart above, PBR historically enjoys high profit margins. PBR's profit margins are so exemplary that in the previous 10 years, only 5 quarters have been below 10%. This essentially means that about 90% of the time, PBR is able to keep a net income of $10 for every $100 of revenue. This high level of profit margin is excellent and very few firms retain the ability to perform so consistently across long timeframes.
Despite such a robust history of strong profit margin, PBR has struggled in the previous quarter. During the previous quarter, PBR experienced a net loss of $1.98 for every $100 of revenue it earned. Basically, this means that PBR lost $685 million in the previous quarter. It is my belief that this loss is an aberration - I do not believe that it will happen again. I base this belief on 10 years of operating data. In the previous 10 years, this is the worst performance from a profit margin standpoint that PBR has experienced. This loss bucks the trend of a 10-year average profit margin of over 10%, and I believe that the market has had a speculative "knee-jerk" reaction which affords the intelligent investor an excellent buying opportunity. I do not believe that we should not also make the mistake of reflexive thinking, but we should rather think through how best to invest in this organization.
I believe that the best method of approaching PBR is using a logical price-based entry. If we are able to isolate key levels in the price of PBR, then we will be better able to enter at the most appropriate moment. Let's start with an examination of the monthly performance of the stock.
The above chart shows the previous 6 years of stock price history for PBR. The stock has two very clear ranges in which it has historically found support for falling prices or resistance to rising prices. I have annotated the chart to show these key regions. The most relevant support region is $18 per share. In 2005, price found resistance at this level, and in 2006, 2008, and 2012, price has found this $18 level to be support. I view this as a floor to our analysis - as long as price remains above this level, I believe that a purchasing opportunity is warranted. My primary argument is that PBR has a very strong and robust history of generating exemplary profit margins and that the recent drawdown of profit is an aberration which will be corrected in the next few quarters. If my argument is incorrect and a true downturn in the organization has begun, then exiting any long positions at $18 per share will allow investors to cut their losses quickly.
I believe that simply purchasing into the stock at this moment would be committing a rash mistake just like investors who are currently selling based upon this previous quarter's loss. I believe that we should define a logical zone in which we will enter the trade which will prove without a reasonable doubt that the market does indeed agree with our analysis. This level can be found at the descending line as seen in the above chart. The market has rallied to this line 4 times and each time it has found resistance and price has collapsed. Since the market has continued to find resistance at this descending line, then we should not enter into this stock until price is able to overcome this level. Practically, this means that we should not purchase the stock until price closes above $25 per share.
As a brief aside: it is very interesting to see that the descending line has been touched 4 times. Within trend analysis, there is a little known but frequently true saying which is "trend lines tend to be broken after the 4th touch." Essentially, this means that prices tend to overcome an established line after it has tested the line 4 times. This is an anecdotal saying and one which is not entirely intuitive; however, it is an interesting tidbit to acknowledge because an entire school of investors and traders who are following this stock will be attuned to any test of the descending resistance line in anticipation of an upward breakout.
My fundamental thesis is that PBR is a very strong organization which has a consistent history of excellent profit margins. It is my belief that the recent quarter of losses is not in line with the results that the organization has historically delivered and that in the next few quarters, performance and subsequently share price will rebound. I do not believe that we should rashly enter the market but that we should wait until price overcomes $25 per share before purchasing shares. For existing shareholders who have suffered through the recent declines in price, I suggest that you continue to hold your shares and earn the (erratic) dividend that PBR offers. If price falls below $18 per share, however, I believe that long holders should sell their shares and I will consider this analysis to be mistimed.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.