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Troubled by Government: Oil in Brazil and China
Posted by: Vanina Egea (IP Logged)
Date: September 11, 2013 05:11PM
The debate is always the same: Should the government intervene in the private sector? Some say yes, others say no, depending on which side of the political spectrum they are. Here are the cases of China Petroleum (SNP) and Petrobras (PBR), companies in which government meddling has not been beneficial.
Is Spying Worth the Time?
Petrobras is Brazilian state owned and operated oil and gas integrated company. As the largest in South America, it has recently made the news when Snowden made public that the NSA was spying on the firm. Besides the tabloids, the company has a market cap of $105 million and a moderate to weak balance sheet. So, can the upcoming international events to be hosted by Brazil help improve its performance?
In the short run, Petrobras will be looking to overturn last quarter’s slower than expected performance due to weaker production at the Campos Basin. Additionally, the company’s forward strategy will need to be reviewed in order to comply with new government regulation. This is the most worrying aspect for its forward outlook, because it may force the company to make overly risky investments to comply with regulation. Moreover, being forced to compete with worldwide oil giants in its own grounds will reduce funds for organic growth.
For the long term, Petrobras is, without a doubt, the most capable explorer and producer in South America. In other words, even if international competitors win biddings in Brazil, they will require a know-how that only the Brazilian firm possesses. The knowledge garnered over the years is such that the company is the global leader of the pre-salt oil segment.
But, government meddling continues to cut revenues short by pushing the company to sell domestically at a discount and invest in low returning capital assets to increment refining capacity. It is worth noting that the state owns 63% of the shares.
Today, Petrobras trades at 7.5 times its earnings, carrying a 20% discount to the industry average. Holding great reserves, the company is an interesting investment. However, extracting those reserves imply heavy investments from the corporate side. Given the increasing political meddling and new regulation, there is uncertainty over whether those funds will be available. That may be the reason why George Soros stopped buying shares more than two years ago, and the latest moves made by other gurus tended towards reducing their positions.
China Petroleum is somewhat different than Petrobras in its structure. The company holds an important chemicals segment in addition to its integrated oil and gas operations. The latest news indicates that the company incremented earnings per share over 20% year-over-year, with a similar figure for net profits. Achievements were conquered amid a slowing Chinese economy that grew at an average 7.6% during the first half of 2013.
At the moment, China Petroleum is focusing on improving the performance of the marketing and distribution segments for the oil sector, and overall performance of the chemicals sector. In the short term, higher oil prices related to the possibility of military action in Syria may help the company to set performance in the right path. However, another business strategy will have to be developed if growth is to be sustained in the long-term.
The most worrying item for China Petroleum, however, is the maturity of the current assets. These, in time, will imply higher operating costs in a country where government regulation has already placed a cap oil prices. Meaning, higher production costs will not be allowed to be transferred to the customer. The situation does not replicate in the chemicals segment. However, that segment continues to report lag behind expectations, and there are worries about inflation affecting feedstock prices.
Currently, China Petroleum has entered the warning zone with respect to finances. Operating margin and cash flow is razor thin, but revenue continues to climb. Trading at 8.4 times its earnings, carrying an 11% discount to the industry average, the stock is undervalued. But, associated risks and uncertainty are so meaningful that Jim Simmons reduced his position by 45%, while Bruce Kovner opted out completely.
In the end, I feel that governments have placed great effort into doing politics with these two companies. Additionally, both countries are well known for considerable degrees of corruption. Hence, I am bearish about both stocks. However, Petrobras concerns me the most because international events are yet to be completed and social disruption can increase political tension, enticing officials to use the company politically.
Disclosure: Vanina Egea holds no position in any stocks mentioned
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