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Should You Go Long Petrobras?
Posted by: Fede Zaldua (IP Logged)
Date: October 15, 2013 05:28PM

I never liked having a government as my partner. Usually, regardless of the political sign, government incentives are radically different to common shareholders' interests. This is the main reason why I have never been a shareholder in Brazil's Petrobras (PBR). Indeed, the Brazilian government pushed the oil major to sell its products at heavily discounted prices and management's decisions were many times influenced by a populist agenda.

All the above being said, the stock looks fundamentally cheap. Above all when we take into account that, for the first time in a number of years, the company's results are starting to show the gradual improvement that is mandatory to re-gain investor confidence.

Results Seem Encouraging

Petrobras is already in the middle a of what seems to be a successful turnaround. The company is taking the necessary steps to increase its top line through price increases and higher output while adjusting costs to ameliorate margins. Production has indeed turned with June being 4.6% higher than May, lifting costs seem to be stabilizing and refinery is posting a 99% utilization rate helping to reduce imports by 31% quarter over quarter.

If Petrobras's management is able to implement a transparent domestic pricing policy (not very politically attractive), the company might constitute a multi-year investment case. Of course, last quarter's results also came with some not-so-great surprises. Petrobras's net debt to EBITDA went from 2.3 times to 2.6 times. This doesn’t look like a comfortable level for an oil company with an intensive Capex schedule and negative free cash flow generation. Nevertheless, I expect Petrobras to de-leverage itself through the sale of non-core assets such as Petrobras Argentina (PZE) – where Petrobras has a 67% controlling stake that could fetch a price as high as $1.7 billion if the company's equity is valued at the reasonable price of $2.5 billion.

Price Is What You Give, Value What You Get

Petrobras is currently trading at an historically low level. The company currently sells for 2014 5.3 times EV/EBITDA, 6.3 times earnings and 0.5 times book value. This compares positively to most Latin American integrated oil companies. Only Argentina's recently nationalized YPF (YPF) trades at a cheaper level than Brazil's Petrobras – YPF, which is held by Richard Perry, sells for 2014 5.6 times earnings and 2 times EV/EBITDA (according to Credit Suisse's estimates).

For example, Colombia's state controlled Ecopetrol (EC), which has recently posted weaker results (its EBITDA decreased by 3% year-over-year) currently trades at 12.5 times earnings and 7.1 times EV/EBITDA. Of course Ecopetrol's dividend yield (at 6%) outshines Petrobras's common shares's cash dividend yield (currently at 0%) but you always can purchase Petrobras's preferred shares that are currently offering an attractive 5.5% yield.

Bottom Line

After a lackluster 2013 year, Brazil seems to be regaining growth momentum. Hence, this might be the time to start looking at Brazilian assets. Petrobras – which represents 10% of the Bovespa index – looks like an attractive turn-around story to take a position in a country that might come back into investor's radar. Petrobras is now held by Ray Dalio and David Dreman.



Guru Discussed: David Dreman: Current Portfolio, Stock Picks
Ray Dalio: Current Portfolio, Stock Picks
Stocks Discussed: PBR, PZE, YPF, EC,
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