I wrote about an odd disconnect
and a strong U.S. dollar.
Since then, that disconnect has dissipated. The dollar has
appreciated about 6% to 7%, and inversely, the price of West
Texas Intermediate crude (
) has fallen at about the same rate. Two of my recommendations,
Phillips 66 (NYSE:
, have gone up an average of 32%.
The third recommendation was integrated Brazilian oil producer
Petroleo Brasilero (NYSE:
,aka Petrobras. Since then, the stock has fallen 26%.
Do I still like it? More than ever.
Another BRIC Faces
Not long ago, Brazil and its fellow BRIC nations were the world's
fastest-growing emerging-market economies.
Now? Not so much. Each country has its own challenges.
Brazil, in particular, is facing unemployment, a weak
currency, inflation, and pockets of social unrest. The currency
weakness is one factor affecting Petrobras' stock price. Others
include below-forecast oil production and low domestic fuel
prices. But the low stock price doesn't tell the whole story.
Petrobras is one of the world's largest oil and gas companies
in all aspects of exploration, production, refining,
transportation and marketing (thus the moniker "vertically
integrated" oil company). It also happens to be half-owned by
Brazil's government. Despite that risk, the stock is more than
worth a look.
While earnings and revenue have basically been flat over the past
two years, at least they're predictable. The company hauled in
$144 billion in 2012 and $141 billion for 2013. Not bad,
considering the macroeconomic challenges. Earnings per share (
) were equally lackluster at $1.67 for 2012 and $1.68 in 2013.
Long-term debt-to-capitalization isn't outrageous at 36%. The
dividend payout ratio is an incredibly low 11% (compared with my
threshold of 60%).
So why am I so excited about a stock that I got wrong last
year? Assets, both existing and potential.
Petrobras' exploration costs rose nearly 50% year over year.
This is a crucial component of their ability to do business. The
company spends roughly $40 billion annually on capital
expenditures of which exploration is the lion's share. Management
has also committed to keeping debt-to-long-term capital between
25% and 35%. In order to accomplish this without incurring new
debt while sufficiently funding its
needs, the company must rely on its cash flow and asset sales --
and there are plenty.
In November, Petrobras sold its Peruvian assets to China
National Petroleum for $2.6 billion. The company is also involved
in many joint ventures, such as a 50/50 African oil production
project from which Petrobras expects to gross $1.5 billion.
But the real story is underground. Currently, Petrobras has
proven reserves of about 13 billion barrels of oil equivalent (
). I'll repeat that: 13 billion.
Historically, Petrobras bases its modeling on the price of
Brent crude at an average of $100 per barrel. I prefer to use WTI
crude, which is always a bit lower than Brent. So, using the
current price of WTI at around $98 a barrel, Petrobras is sitting
on reserves worth nearly $1.3 trillion.
That makes the company's $67.6 billion market cap look like
change in the sofa cushions. Calling this stock a bargain is an
Risks to Consider:
The most glaring risk is the Brazilian government's control
of the company. Owning 50.3% of the shareholder voting rights,
nationalization of a $1 trillion asset is a constant threat (see:
Venezuela). Political instability and domestic economic
uncertainty don't help in alleviating that threat. Other risks
also include weak emerging market economies, as well as falling
oil prices. Despite a decline in oil prices, Petrobras' massive
reserves, predictable cash flow, and unlocked value offset that
Action to take -->
Petrobras shares look extremely cheap at $10.40 with a forward
price-to-earnings (P/E) ratio of 5.9 and a dividend yield of
3.5%. If management can accomplish its goal of investing in the
business through asset sales and organic cash flow, which it has
the reserves to accomplish, without incurring new debt, a P/E
expansion to 10 is more than probable. The result would be a
12-month price target of $18. Factoring in the dividend, the
potential total return exceeds 75%.
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