Stock of the Week - Petroleo Brasileiro SA (PBR)

Each week I’m going to provide an in-depth analysis of one holding in my portfolio, starting with the Brazilian energy company Petroleo Brasileiro SA, more commonly known as Petrobras. It trades here in the U.S. on the NYSE as an ADR under the symbol PBR.

Petrobras is getting press again this week with the news of a potential new discovery in the Santos field that could total as much as 33 billion barrels. Now, mind you, I bought the stock (on a brief pullback) following the news of the Tupi field discovery, which is now estimated to be about 8 billion barrels.

To put it in perspective, the largest oil field ever discovered is in Saudi Arabia and is called Ghawar. That field was estimated in 1970 to have 170 billion barrels of original oil in place, with about 60 billion recoverable. To date the field has already produced 60 billion barrels and continues, at least for now, at a rate of about 1.825 billion barrels per year (approximately 6.25% of world production). For a fantastic treatment of Ghawar, Saudi Arabia, and petroleum geology in general, please read: Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy.

You may also want to read my previous post The Battle of Demographics and Non-Renewable Resources for additional thoughts on why oil is such a big deal.

Petrobras published proven reserves of 13.920 billion barrels of oil equivalent (boe) on December 31, 2007. However, this doesn’t include anything from Tupi or Santos. You can see how going from 13.920 to, 21 billion bbl to 54 bbl is a huge increase. By comparison, in private industry, the world’s largest corporation, Exxon-Mobil (XOM) has proven oil reserves of about 11.35 billion bbl and a “resource base” of about 72 billion bbl. So if these discoveries are verified at their current estimates (I’ve read some press indicating that the Tupi estimate of 8 billion may prove closer to 30 billion also), these new fields could put Petrobras on equal footing with industry giants like Exxon-Mobil.

Continuing the comparison, Petrobras had revenues of 100.98B USD in 2007 versus Exxon-Mobil’s 2007 revenues of 361.71B USD. Then again their market caps reflect this comparison, Petrobras weighing in at 270B USD versus Exxon-Mobil at 485B USD. The disparity in the ratios here of revenue 1:3.6 versus market cap 1:1.8 certainly reflects some of these new fields already being priced into the overall Petrobras evaluation at this time. Three more key indicators to round out the comparison would be profit margin, operating margin and trailing P/E. They are, Petrobras first, respectively, 12.61% vs. 11.23%, 23.51 vs. 16.80% and 21.2 vs. 12.5.

As such, you probably won’t be surprised when I tell you that XOM returned 15.82% in the last 52 weeks (price change only) and PBR returned 134.07%. Of course, as a Brazilian company, a significant portion of that return is the slide of the USD versus the Brazilian Real. And while I’m still bearish on the USD long term, I doubt we’ll continue to see the kind of price erosion we’ve seen in the last 3 years.

Clearly I am very bullish both short and long term on the prospects for Petrobras. And I haven’t even discussed gas or ethanol (probably the subject of another post). But do I like it at this price? The ADR is trading at about 123 USD as of this writing. And the answer is, no. Personally, I’d wait for a bit of a pull back (Fitz agrees). The market seems to have a habit of overreacting to both positive (field news) and negative news (oil commodity price news) where Petrobras is concerned. In other words, it’s highly volatile (as the Beta of 1.29 clearly indicates).

I purchased my current holdings closer to the long term historical average P/E for PBR, which is around 16. If you like this stock, which is really a growth and not a value play, despite the industry vertical, you will likely not be able to buy it on the cheap. That said, given the volatility, I would wait for a chance to pay closer to its (current) fair value. I’ve seen swings of 5% in a single day.

Here’s quick wrap up of current analyst price targets: Citigroup R$115 versus the current price of about R$103. Also, Credit Suisse targets the ADR for US$165 versus about US$123. All the analysts I could find seem to be in a band between 15-30% from the current price level, and they are all assuming long term oil prices of US$75 per barrel (which is hopelessly optimistic, meaning too low, if you ask me).

I personally don’t pay too much attention to price targets, as I’m a long term buy and hold guy, but their worth noting as part of your analysis. Me personally, I could easily see PBR overtaking XOM as the largest company in the world (market capitalization and revenue) within the next 10 years (you can do the math on that as my price target if you like).

I’m going to try to figure out how to show my whole portfolio dynamically on the site, without giving away my net worth. Anyway, for now, shares of Petrobras (PBR) that I own directly comprise about 8.4% of my total portfolio. I also own at least 3 funds (mutual or ETF) that own PBR as well. Currently my stake is up over 30% from when I bought it in early December 2007.

By way of final thoughts, here is a summary of the pros and cons for Petrobras.

Pros

Oil prices have nowhere to go but up, long term, but PBR looks good even at $75 per barrel oil
Huge proven reserves, even larger unproven reserves
Well positioned in Oil, Gas, and Renewable Fuels

Cons

A bit pricey at the current trailing P/E of 21.2
There is always the potential for the Brazilian government to mess with them down the road (think: de-privitization)
As with any foreign stock, future currency exchange rates can be your best friend or worst enemy