The Rising Influence of Rising Affluence

[DewDiligence]

I’m not a fan of PBR for the reasons cited in #msg-51214642. This Barron’s
article presents the opposing view, which I would characterize as naïve.

http://online.barrons.com/article/SB50001424052970203296004575338572714305994.html

›Drilling for Value in Petrobras Shares

JULY 3, 2010
By DIMITRA DEFOTIS

The Brazilian oil giant Petroleo Brasileiro, or Petrobras, has made some of the biggest oil discoveries in the world in recent decades, sandwiched in salt beds deep below the country's coastal waters. Eventually the company's latest finds could double existing reserves of more than 12 billion barrels, while production could pump up earnings well beyond this year's expected $3.85 per American depositary receipt (ticker: PBR).

Yet investors have been fleeing the company's shares, spooked by the Brazilian government's plan to grant Petrobras production rights for up to five billion new barrels in return for more stock and greater control. The complex maneuver also will feature a stock offering in the fall that will enable private shareholders to increase their stake, with the size and price to be determined after independent auditors value the barrels involved in the swap. [How independent will these auditors really be?] The government, which formed the company in 1953, owns only a third of the shares. But it retains 55% voting control in Petrobras [there are two classes of shareholders (voting and non-voting), and the government owns a majority of the voting shares], which has a market value of $143 billion.

While there is ample cause for concern about greater state control, as well as the $224 billion cost of the company's proposed four-year development plan, the selloff affords an attractive opportunity for long-term investors. Petrobras' ADRs have fallen 35% in the past seven months, to around 34, or 7.4 times next year's expected earnings, erasing the valuation premium they once enjoyed relative to most other large integrated oil companies. The ADRs now trade below Exxon Mobil's (XOM) price/earnings ratio, though above the valuations of other majors. Bullish analysts expect the stock, which once traded as high as 17 times earnings, to rebound to 50 or so in the next 12 months, as the uncertainty surrounding the government's transfer eases and the earnings outlook improves.

Petrobras projects oil production will increase by 9.4% annually to 3.9 billion barrels a day by 2014 [in the same ballpark as XOM and BP], and double by 2020—a much faster growth rate than that of other big producers. Analysts expect earnings to increase by 17% in 2011, to $4.52 per ADR, and 6% in 2012, to $4.81. [These forecasts are hardly trustworthy insofar as no one knows how many shares will be outstanding after the recapitalization.]

Although Petrobras' production is concentrated in Brazil, the company operates in 27 countries, primarily in Latin America and Africa. Exploration and production accounted for 24% of last year's $92 billion of revenue, but 55% of operating profit; "supply," primarily refining, contributed 47% of revenue and 37% of profit. Smaller units include oil and ethanol distribution, and domestic natural-gas distribution. Petrobras disclosed last month that it will spend $73.6 billion, or a third of its four-year budget, on investments in refining, which historically has yielded lower returns than production. The news stirred fears the move may be motivated by the government's desire to create jobs.

Petrobras' reserves are more than 80% crude oil, a higher concentration than any other major producer. With crude prices up 27% in the past year, to the mid-$70s a barrel, the company's shares should have headed higher. That they instead fell is a reflection of investor confusion over the government's asset-transfer plan. Some on Wall Street also are worried about the massive production and development costs the company will incur in coming years, outlays that could be even higher after BP's deepwater disaster in the Gulf of Mexico.

To CEO Jose Sergio Gabrielli, 60, a former economics professor, falls the challenge of balancing Petrobras' capital needs, the Brazilian government's social agenda and the complaints of private shareholders, who will be diluted by government's increased stake. [LMAO re the wording of the previous sentence.] A Petrobras spokeswoman declined to make Gabrielli available for an interview, citing the pending offering, which could raise up to $85 billion for the company.

The auditors' assessment is expected sometime in August, and the share sale is likely in September. Both will afford more clarity for investors. Petrobras consistently has delivered outsized production growth and profits. The stock's downdraft, in turn, has delivered a bargain for investors, who could find their shares sharply higher as the waters calm in coming years.‹