Petrobras Looks More Compelling Than Ever

The sell-off in oil from its high of nearly $150 a barrel has been well publicized and many energy stocks that rode that wave up are now reeling as the price of oil plunges. Petroleo Brasileiro S.A. (PBR)—the state-controlled energy company of Brazil, commonly referred to as Petrobras—is one such stock that reached levels that we view as overvalued (see ratings chart). However, after dropping more than 30% from its recent high in little more than 3 months, we have upgraded Petrobras to a Buy rating as of this week. Value investors should be moving in as the speculators sell. While the rapid drop in price may scare some investors, we believe there is significant value in these shares for long term investors.

Petrobras could be sitting on one of the largest oil fields discovered in years in the Tupi-area fields. Estimates for the Tupi field reserves range from 5 billion to 8 billion barrels (85% light crude) and that would undoubtedly provide a healthy revenue stream for years to come. Interestingly, PBR has put a 12 to 18 month hold on drilling those fields while they conduct seismic and other various well tests. Perhaps they are also buying time to acquire rigs and raise the capital to operate them. The reserves in Tupi would require deep water rigs, which are not cheap to operate. The company plans to spend more than $200 billion to produce the crude. Petrobras has moved quickly to lease many of the deepest offshore rigs (source). With the price of oil in constant flux, there is no way to accurately predict what the earnings will be from this field, but we believe that it is reasonable to assume that oil will not drop markedly below $100 a barrel for any sustainable period of time and certainly could go far higher.

In addition to the much ballyhooed Tupi field, Petrobras has made other, albeit smaller discoveries. Earlier this month Petrobras began drilling in the Jubarte field in the Campos Basin with production potential of around 18,000 barrels per day. Also, they are eagerly exploring other potential off-shore sites hoping to find the next Tupi. PBR has partnered with some of the biggest American (XOM), (HESS) and international (REP), (RDS.A) energy companies to leverage their experience and expertise. In a short time, Brazil has quickly become a major player in oil and gas exploration.

Most of the blame for the sell-off in PBR shares is correctly attributed to the decline in crude oil prices. However, recently the stability of the company has been called into question as there are grumblings about a possible nationalization of PBR. The Brazilian government already holds a majority stake of PBR and has talked about increasing its stake in the company. There have been threats of oil workers strikes and other signs of unrest coming from Brazil. This is clearly a cause for concern for investors—and the company—but up to this point, PBR has affirmed that it will honor all existing contracts.

Returning to the stock’s valuation, as we mentioned before, it looks far more compelling than at any other period since we initiated coverage of PBR. The company is coming off of a tremendous, record-breaking second quarter. We particularly like the growth of revenues, which climbed more than 30% in the quarter over a year ago. Over the longer term, revenue has grown 220% over levels seen five years ago without even a drop coming from Tupi. At current price levels, PBR is selling within its normal price-to-sales and price-to-cash ranges, after trading far above their historically normal range for some time. We see this as an interesting growth stock to add to an international portfolio, especially for those that believe the price of oil will eventually be heading higher in the future.

Comments

[phdinsuntan...:]

PE in 7 and we talk

2008 Sep 11 08:25 AM

[Brian Pursley:]

The nationalization and Chavez talk is what has created this buying opportunity. I believe the Bolshevik rhetoric is meaningless and the risk is political hype.

2008 Sep 11 11:51 AM

[Scott Benson:]

Um, Chavez is in Venezuela, not Brazil. Two different countries. Plus, even if Chavez nationalizes more of HIS stuff, his country is an inflation nightmare, with shortages of all the important materials. His model for the future cannot stand. And if you were referring to some kind of "Brazilian Chavez" angle, I'd say it won't work long term.

2008 Sep 11 12:20 PM

[Scott Benson:]

Not to mention it is going to be incredibly expensive (moreso even than you said) to get the Tupi/Carioca oil out, if you even can get it out.

2008 Sep 11 12:22 PM

[Brian Pursley:]

Scott, we are well aware that they are two different countries however Lula Da Silva wants to be the next Chavez. Thus they are analogous.

2008 Sep 11 12:50 PM

[torto:]

People are not doing their homework when it comes to PBR. It is actually a net importer of light crude, because it is an integrated oil company and it does most of the light crude refining in Brazil. Before recent discoveries, PBR produced almost only heavy oil and exported it to be refined abroad, and only now it is coming closer to a dollar break even between imports and exports.

So its profit today is due to refining, distribution and exploration in foreign countries ONLY, and was actually hurt by higher oil prices and state subsidizing of gasoline prices. What one must think of when analyzing PBR is oil prices in the next 30 yrs (and ethanol etc.), because the recent spike in oil did nothing but reduce PBR's margins.

P/E may reach 7 if all speculative capital leaves Brazil in the short term but for long term investors it seems me very attractive right now (as Soros does: seekingalpha.com/artic...)

2008 Sep 11 05:08 PM

[The honest ...:]

Nice call..

Stock was 10% up today (in reais, not dollars)

2008 Sep 11 08:27 PM

[fxtrader07:]

I would have loved the author backed up his 'cheap valuation' rhetorik with some numbers. Actually Tupi may soon become a millstone rather than an asset. It seems increasingly likely that current technology will be hardly sufficient to extract the oil and/or it will get very very costly to do so. It is a very big oil find, yes - but if the margins are too thin at $80-$100/bl oil other oil companies may actually offer the better deal. And make no mistake: nationalizing oil assets will be a continuing and escalating trend. Oil will remain THE strategic resource du jour. For me, there are way too many potential risks (execution, operation, political, currency) involved to justify a buy of PBR. I think there is still a lot of hot speculative money sitting in the stock.
And btw: those 200bn have to come from somewhere. PBR currently doesn't make remotely the cash flow and profits needed to finance these huge projects.

2008 Sep 12 07:10 AM

[Alan von Al...:]

On Sep 11 05:08 PM torto wrote:

> [Petobras] profit today is due to refining, distribution and exploration
> in foreign countries ONLY, and was actually hurt by higher oil prices
> and state subsidizing of gasoline prices. What one must think of
> when analyzing PBR is oil prices in the next 30 yrs (and ethanol
> etc.), because the recent spike in oil did nothing but reduce PBR's
> margins.

Sorry to quibble.
Exploration & Production 29% of 2006 revenues 81% of operating earnings
International Operations 5% of 2006 revenues 1% of operating earnings

2008 Sep 12 07:12 AM

[Steven Ward:]

Lula is not nutty like Chavez.Lula the Lefty isn't so left at all. He told the municipal workers unions that there will be no raises in wages. these unions are his biggest supporters. Lula has run a rather firm fiscalpolicy.
Additionally, Lula voted no on Venezuela's entrance into the economic union in the cone of south america thus freezing Chavez out.

Reports indicate that Lula is beefing up the military to make sure Chavez doesn't interfere with Brazilian stability.

Lula is not Chavez and wants foreign investment in other areas. He's treading carefully,but we still don't know what he's going to do.

2008 Sep 12 09:48 AM

[svkoho:]

The comments here point out and emphasize points that the author glossed over. The issues as I see it are: 1.what will be the net cost to produce Tupi oil? It will be high and that is assuming PBR can find the rigs and people to man them in any reasonable time frame. Where will the money come from? 2. What happens to PBR's stock when the company is nationalized? I said WHEN not IF.

2008 Sep 12 10:18 AM

[CHARGER:]

America desired cheaply produced household/clothing commodities and China became world power meeting this need.
America needs RELIABLE OIL SOURCES FOR NEXT TEN YEARS and
a partner in Brazil clearly can bootstrap itself to similar world status by
early action to encourage responsible investment-- in all of Brazil

2008 Sep 12 10:23 AM

[Alan von Al...:]

Cal48: I don't expect Brazil to nationalize PBR, primarily because it already is. Lula's govt has majority control of voting shares, appoints all management, sets capex, imports, thermal power, retail prices. Floating ADRs raised capital. Announcing big reserves postponed the matter of paying dividends and drew in vendor financed big ticket iron. Happy ending for Brazil. Zero exports to the US.

2008 Sep 12 10:48 AM

[Paul Killinger:]

Why do you say zero exports to the U.S.? If Brazil really has stumbled upon a Saudi-sized oil field, what are they going to do with the stuff? They are already energy independent, so they don't need it domestically. And they're not spending billions to keep it off the market. Where else could they sell it more economically?

2008 Sep 12 11:23 AM

[Scott Benson:]

If Venezuela continues to make overtures towards cutting off oil to the U.S. (to send to the damn Chinese), Brazil may just have a place to sell it. :) We'd need to replace 1 mbpd that we'd normally get from Venezuela then. But today, very little Brazilian oil comes to the U.S., and since Brazil is a huge country and is set to become a global superpower, and its birthrate is healthy, and since everything is so far apart in Brazil, don't be too surprised if Brazil needs all their oil to push all their diesel equipment. Everyone thinks Brazil moves on sugarcane ethanol. It doesn't (ethanol is 20% of transportation fuel at best). It uses and needs diesel.

2008 Sep 12 12:07 PM

[einstein p ...:]

Brazil may be socialist, be there is NO comparison to Venezuela.
Chavez and Lula couldn't be more different. There may be other reasons to not like the stock --- but mistaking Brazil for Venezuela is silly. BTW ---- AvA is right ---- PBR is already nationalized.

Go out and buy some NOV if you're worried about PBR --- they are going to need a ton of new rigs and platforms anyway you slice it.

2008 Sep 12 01:48 PM

[Alan von Al...:]

paulk: I disbelieve economically recoverable giant oil field in subsalt. I think what they have is primarily gas, which Brazil needs for thermal electricity generation. Moreover the reserves estimates are wrong. My opinion only. Let's wait and see what Exxon says.

2008 Sep 12 08:08 PM

[Paul Killinger:]

Alan,

That's very interesting. Conventional NG at that depth, or possibly gas hydrates? The preliminary size of the find indicates it could by VERY substantial. Like you say, we'll see.

Speaking of which, gas hydrates are going to be the stealth energy source in our future. Ol' Boone is just warming us up by getting us to switch over to NGV's. NG is destined to become the U.S. transport fuel of choice for the rest of the 21st century.

Relatively cheap, clean and abundant, with a virtually inexhaustible domestic supply. Perfect! (Not to mention NGV's were a 60 year old overlooked technology just waiting to be rediscovered. Nostalgic for old geezers like me... ha, ha!)

2008 Sep 12 10:12 PM

[Paul Killinger:]

P.S. Now that the D's in Congress have finally gotten religion about domestic energy exploration, here they go again (as RR used to like to say). Their new game plan is to tax oil and gas to develop EV's. They could just as sensibly put matches to the money instead. And that's the one thing they're good at, burning our cash!

2008 Sep 12 10:26 PM

[torto:]

Alan,

> Sorry to quibble.
> Exploration & Production 29% of 2006 revenues 81% of operating
> earnings
> International Operations 5% of 2006 revenues 1% of operating earnings

it's ok to be quibble when one's trying to show some concrete data -- this is YOUR (wrong) interpretation of the balance... "exploration and production" may carry many meanings of course, it's not only oil

the fact is, PBR is highly profitable today with high oil prices even though it's an oil IMPORTER, near breaking even. So falling oil prices in short term are good for them, as strange as it may sound -- it's long term oil that counts.

PBR exports gasoline (low demand in Brazil b/c of ethanol) and machinery, and imports diesel (high demand in Brazil b/c transport infrastructure depends mainly on trucks)

it's that simple >> uk.reuters.com/article...


regarding all other issues (dividends, political risk etc.), I totally agree with you

2008 Sep 16 11:06 AM