This 'Bargain' Oil Giant Offers 75%-Plus Upside
Since then, that disconnect has dissipated. The dollar has appreciated about 6% to 7%, and inversely, the price of West Texas Intermediate crude ( WTI ) has fallen at about the same rate. Two of my recommendations, Valero (NYSE: VLO ) and Phillips 66 (NYSE: PSX ) , have gone up an average of 32%.
The third recommendation was integrated Brazilian oil producer Petroleo Brasilero (NYSE: PBR ) ,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 ( EPS ) 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 capex 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 ( BOE ). 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 understatement.
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 risk.
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%.