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Petrobras’ Pasts Mistakes and Current Outlook Facing Years to Come

March 21, 2014 | About:

Petroleo Brasileiro (PBR), headquartered in Rio de Janeiro Brazil, was founded in 1953 and remained as a legal oil monopoly for the country until 1997. It is the largest company in the Southern Hemisphere by market capitalization and the largest in Latin America measured by 2011 revenues. The company owns oil refineries, oil tankers, is a major distributor for oil products and a leader in developing technology for deepwater and ultra deepwater oil production.

In 2010, the company conducted the largest share sale in its history, selling over $72.8 billion shares. The stock was sold in the BM&F Bovespa stock exchange market, becoming the fourth largest company in the world by market capitalization.

Though the company has been in decline in the last few years, it has recently launched a plan to reduce costs by $8 billion per year in the next four years. However, this being an election year, it is possible that the government won’t want to update domestic prices to international ones, thus causing huge losses for the company.

Petroleo Brasileiro SA Petrobras ADR Profitability Analysis

Looking at profitability is a very important step in understanding a company. Profitability is –essentially  the reason behind a company’s existence, and a key component in deciding whether to invest in or maintain your investment in a company. In this article I will look at Petroleo Brasileiro SA Petrobras ADR (PBR)'s earnings and earnings growth, profit margins, profitability ratios and cash flow. In addition, I will evaluate which institutional investors bought the stock in the recent quarters.

If you go back through the history of the stock market, there is a recurring theme among those stocks which have had some of the strongest price appreciation, and it's related to their earnings growth. If you plot a chart of earnings growth versus a company's stock price there is usually a strong relationship between the two of them. So, the first step when analyzing Petroleo Brasileiro SA Petrobras ADR is evaluating its earnings potential.

The company generated -15% EPS growth last quarter compared to the same quarter in the past year.

I am looking for growth stocks that generate more than 15% quarterly EPS growth. It is essential to evaluate why Petroleo Brasileiro SA Petrobras ADR generated less than that.

Sell-side analysts just upgraded EPS projections for the company, increasing EPS estimates by -46.16% for the current year.

I also look at the three-year annual average EPS growth rate to get a perspective on how the company grew in the recent years. PBR generated -21.69% annualized average EPS growth in the past three years.

I do not like that Petroleo Brasileiro SA Petrobras ADR grew less than 15% per year in the past three years. Fifteen percent is the minimum annual growth level I am looking for when investing in growth stocks. This fact does not prevent me from potentially investing in PBR, but it is certainly a warning sign that cannot be ignored.

A key step in analyzing Petroleo Brasileiro SA Petrobras ADR is studying how sales grew in the recent quarters or years. Why is this important? Well, revenue growth cannot be masked with accounting tricks or via cost-cutting strategies. This metric tells you in simple terms how demanded a company´s products or services are.

The company reported a 16% quarterly revenue growth year over year.

PBR generated strong quarterly growth levels. I am confident on Petroleo Brasileiro SA Petrobras ADR´s continued success in emerging economies.

I find the fact that revenues grew more than earnings per share very encouraging. This is a very important ratio because both sales and earnings must grow at same levels. If a company generates strong EPS growth levels and even stronger revenue growth levels, I tend to feel very bullish about it. Petroleo Brasileiro SA Petrobras ADR generated quarterly EPS growth of -15%, while sales grew by 16%.

It is important to watch beyond quarterly earnings, which are more short-term oriented. It is also crucial to pay attention to how annual sales grew in the past three years. Petroleo Brasileiro SA Petrobras ADR reported an average annual sales growth of 16.19% over the past three years over the minimum of 15% I am looking for in these kind of stocks.

The gross profit margin is a measure of a company's manufacturing and distribution efficiency during the production process. It tells an investor the percentage of revenue/sales left after subtracting the cost of the goods/services sold. Investors tend to pay more for businesses that have higher efficiency ratings, as these should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

Reviewing PBR's gross margin over the past five years, an investor can see that the company's gross margin has been decreasing. In fact, the 5-year low for the gross margin was reported at 25.4%. The 5-year high for this ratio was achieved over the past twelve months, when the margin reached 44.5%. However, the TTM gross profit margin of 23.9% is below the five-year average of 36.22%.

A gross margin below the five-year average implies that management has not been efficient in improving this key profitability metric.

Operating Margin = Operating Income / Total Sales

The operating margin is a measure of the proportion of a company's revenue that is left over after paying for variable costs of production, such as wages, raw materials, etc. A healthy operating margin is required for a company to be able to pay for its fixed costs such as interest on debt. If a company's margin is increasing, it is earning more per dollar of sales.

Over the past five years, the operating margin of Petroleo Brasileiro SA Petrobras ADR has been increasing. In 2009, the company reported an operating margin of 21.4%. Over the past twelve months the margin reached 10.6%.

The TTM operating margin of 10.6% is above the five-year average of 8.04%. I am always looking for companies that have improving operating margin trends.

Net Profit Margin = Net Income / Total Sales

A ratio of profitability calculated as net income divided by revenue, or net profits divided by sales. It measures how much out of every dollar of sales a company actually keeps in earnings.

The profit margin is a very useful metric when comparing companies in the same –or similar- industries. A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. Profit margin is displayed as a percentage.

Over the past five years, PBR's net profit margin shrank, compared to the five-year average. The TTM net profit margin of 8.55% is below the five-year average of 12.71%. This implies that there has been a decline in the percentage of earnings that the company is able to keep compared to the company's five-year average.

I think it is important to look for stock with current net profit margins above the five year average margin. Basically, almost all my stock market winners were companies with above-average margins.

ROA - Return on Assets = Net Income / Total Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."

The 2012 ROA of Petroleo Brasileiro SA Petrobras ADR 3.68% is below the five-year average of 7.08%. This implies that the management has lessened its ability to use the company's assets to generate earnings over the past five years.

Free Cash Flow = Operating Cash Flow - Capital Expenditure

A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt.

Petroleo Brasileiro SA Petrobras ADR generated a ratio of cash flow from operations/total sales of (OCFS). The higher the percentage, the more cash available from sales.

If a company is generating a negative cash flow, it shows up as a negative number in the numerator in the cash flow margin equation. This means that even though the company can generate revenue, it is losing money.

I feel encouraged by the fact that Paul Tudor Jones (Trades, Portfolio) and Ray Dalio (Trades, Portfolio) bought the stock in the past months at an average price of $15.62. This shows that hedge funds have confidence in the stock.

Analyst Outlook

Currently, many analysts have a good outlook for PBR. Analysts at MSN money are predicting that PBR will retrieve EPS of $1.67 for FY 2013 and an EPS of $2.29 for FY 2014. Analysts at Bloomberg estimate (C1F)'s revenue to reach $144.89 billion for FY 2013 and $146.24 billion for FY 2014.

Conclusion

Though Brazilian government owns and will own a controlling portion of the company (by law). And they’re upfront about it with shareholders: They often say that they will sometimes pursue their political agenda throughout the company, putting shareholders interests in second place. But, this wouldn’t be always a bad thing as long as shareholders keep a close look on the current administration policies.

The recent discovery of gas and, primarily, oil under a salt layer puts the company on top of the world oil market, since it provides an uninterrupted source of oil for the next 10 years. This should be a good sign as long as the government and company’s CEO Maria das Gracas Silva Foster come to an arrangement in terms of exploration, exploitation and pricing over this new discovery.

On the good side, the company’s new CEO Foster, was honest and upfront about past mistakes and is committed with taking the company up again and lowering production costs. Also, the stock price is near a five-year low of $10.37, which provides an interesting entry point, especially after the new discovery of oil and gas resources.

Disclosure: Vanina Egea holds no position in any stocks mentioned.

About the author:

Vanina Egea
A fundamental analyst at Lone Tree Analytics

Visit Vanina Egea's Website


Rating: 4.2/5 (5 votes)

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