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Investment Thesis
Petrobras (NYSE:PBR) (NYSE:PBR.A), the largest Brazilian oil producer, has not been a good investment over the last 10 years but could become a money-printing machine in the future thanks to internal changes and good external conditions. The company is the 16th largest oil company in the world by market capitalization. In this article, I explain why Petrobras is in an excellent position and why I see a very interesting long-term opportunity for investors, with dividends for decades to come.
The Oil Industry: The Status Quo
The oil industry is a two-edged sword. On the one hand, it's hated for its CO2 emissions and the natural disasters it has caused, and it's already written off by some as an old energy source that will soon no longer be needed. On the other hand, this industry continues to be the lifeblood of the global economy: Because of its unmatched energy density and diverse applications, oil will continue to be needed and consumed in the future (at least the next three decades).
Let's take a look at the currently most important oil-producing countries (top table) and the largest consumers (bottom table).
Source: US Energy Information Administration (EIA)
Three things that stand out to me here: Although the U.S. is the largest producer, it is still an importer. The second and third largest consumers, China and India, together already need almost as much as the U.S., but are far from being able to cover their own consumption. And Brazil, the home of Petrobras, produces only minimally more than it uses.
Current crude oil consumption (and forecasts)
McKinsey estimates that global consumption in October 2021 was about 98.8 million b/d (barrels per day), still about 2 million less than 2019 but about 7 million more than the 2020 average. Further, OPEC expects additional consumption of 4.2 million b/d in 2022, which would then be a new high.
EIA: Short-term energy outlook
What about long-term demand? There is much debate about when oil demand will peak. BP (BP) summarizes these different estimates very nicely in a detailed report:
There is wide range of estimates of the point at which oil demand is likely to peak. Some projections suggest global oil demand could peak soon after 2025, others expect demand to continue to grow out to 2040 and beyond. Indeed, different projections from the same organisation can point to quite different estimates depending on the assumptions used. For example, the IEA’s Sustainable Development scenario, which is predicated on a sharp tightening in climate policies, suggests oil demand may peak in the mid-2020s, whereas its “New Policies” scenario, which envisages a less sharp break in environmental policies, points to demand continuing to grow in 2040.
BP report: Peak oil demand and long-run oil prices
The exact timing of peak oil demand is not that important, because of course even from point, demand will not fall abruptly, but slowly. Whether it is reached in 2025, 2030 or 2035 is only of limited importance. Mankind will continue to consume oil until at least 2050. From today's investor perspective, this means potential cash flow for decades to come.
Some western companies are already reporting that their production will not increase (or even decrease). Shell said, its oil production has already peaked and will "gradually decline 1 or 2 percent annually, underscoring the company’s desire to shift to greener energy." BP said, they plan to cut their oil and gas production by 40% by 2030. Furthermore, there is a great report from the think tank "The Shift Project" that states:
The European Union can expect oil reserves to be depleted by 2030.
And already the EU is the world's largest importer of oil. As if all this were not enough, there are many reports and warnings of too little investment in the development of new sources to be able to meet demand in the future. Just a few examples:
Speaking at the FT Commodities Global Summit, JP Morgan head of oil and gas research Christyan Malek said the bank had identified a $600 billion shortfall of upstream investment needed between 2021 and 2030 to meet what he called a "muted" view of global oil demand.
Source: S&P Global
According to available estimations, investments in the global oil and gas sector worth around $17 trillion are required to support the present production level by 2040, which will equal to around one third of all global investment in the energy.
Source: Rosneft CEO
How it will all turn out in the end remains to be seen. Normally, there is enough investment in the economy when there is the prospect of earning money. In order to make money, crude oil prices must remain above a certain level. I, therefore, think that the times of very cheap oil are over. Especially as it is also politically desired, since expensive oil is synonymous with expensive fuel and should therefore accelerate the switch to renewable energy forms and EVs.
That was a long but important introduction to Petrobras. But in the oil industry, it's the big picture that counts. Therefore, I recommend all interested readers to learn more about this topic, e.g., via the many links in this article.
The Transformation of Petrobras
Petrobras is a partly state-owned company in Brazil, the country with the second-largest oil reserves in South America (behind Venezuela). In the past, Petrobras was part of several scandals, had huge debts and lowered its dividend to zero. The result was investors said goodbye to the stock.
Seeking Alpha: Petrobras Chart
But in recent years, the company has gone through a transformation. Let's start with the debt. In the last 7 years, the company has been able to reduce its debt load by a lot. According to GuruFocus, the debt-to-EBITDA ratio is now 1.23, the lowest ratio in years.
Strategic Plan Presentation 2022-2026
The company states a gross debt long-term target of $60 billion. Now that this target has been reached, there is significantly more money available for investments. Most of the investment from 2022 to 2026 is planned for exploration and production but also for other areas and even decarbonization.
Strategic Plan Presentation 2022- 2026
Most of the E&P expenditure is to be spent on so-called pre-salt fields. Pre-salt fields are offshore oil fields located at very great depths under an additional salt layer that is 200 to 2000 m thick. The depth of the entire well is therefore 4000 m to a maximum of 8000 m deep. Nevertheless, these wells have lower costs per barrel than Petrobras' average. The forward breakeven point is $20 per barrel.
Strategic Plan Presentation 2022-2026
Total oil production is expected to increase from 2.1 million b/d in 2022 to 2.6 million b/d in 2026 - a 24% increase! Also, the percentage distribution should increasingly be distributed to the low-cost pre-salt fields.
Strategic Plan Presentation 2022-2026
Cash Flow and Dividends
Operating cash flow grew from $26B in 2018 to about $35B in 2021. The company itself gives a wide range of estimates for 2022, as the profit depends firstly on the oil price and secondly on the Real/Dollar exchange rate: From $11B in the worst case to $35.8B. At today's price of $75 per barrel and 1 Dollar = 5.57 Real, Petrobras' estimate is about $32.5B operating cash flow for the next year.
Slightly less than this year, but as mentioned, production should increase in the future while production costs per barrel will decrease. And that is still more than enough to meet the new dividend policy and make more than generous distributions.
Strategic Plan Presentation 2022- 2026
There are currently 6.52 billion shares outstanding, and even the bare minimum of $4 billion in dividends would mean 4B/6.52B = $0.61 per share per year, which would translate into a dividend yield of 5.5% at today's share price. But in reality, it will probably be much more. The last quarterly payment alone was already $0.61. Fastgraphs even estimates a 2022 dividend yield of 29%. And by the way, a CAGR of 30% until the end of 2023, based on the historically normal P/OCF of 3.38.
Fastgraphs
Valuation
These dividend yields are possible because the valuation is extremely low at the moment. The P/E ratio for the next 12 months is just over 5. And as can be seen in the Fastgraphs above, the P/OCF valuation is more than a third below the historical average. Accordingly, the company also scores excellently in Seeking Alpha's Quant rating, with very good values in all areas and a total score of 4.98.
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At this valuation and in this market environment, I think Petrobras is a great value bargain that has the potential to continue paying dividends for decades to come. At the current yield, investors will have received the entire investment back in the form of dividends after 4-5 years. And this does not even include potential future business expansions such as renewable energies.
Conclusion
As we have seen, oil will be with us for at least two decades. Some say oil stocks are the new tobacco stocks, which simply means they're unloved by the market and ESG guidelines, but still cash-producing giants that reward their shareholders year after year. As with any stock, no one knows for sure whether everything will really turn out that way in the end, but the general conditions for Petrobras are very good at the moment.
