Petrobras: Overblown Risks Lead To A Massive Opportunity For Investors

2x Earnings And A Double Digit Yield For The Brazilian Oil Giant

Summary

• Petrobras has sold off due to perceived political risks, which are overblown in my view.

• The valuation is dirt cheap and investors have received huge dividends over the last couple years. Now it looks like we could see buybacks as well in future quarters.

• There are several cyclical factors that are lining up to be tailwinds for Petrobras and investors in the company.

• There are two share classes, and I explain why I own the preferred shares, PBR.A.

• Even with commodity risks and the perceived political risks, Petrobras will continue to reward shareholders with huge dividends, which will likely lead to a higher share price over the next couple years.

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Petrobras PBR 0.00%↑ is the large, state-owned Brazilian oil company with a dirt-cheap valuation and a huge dividend. Owning this stock comes with an interesting set of risks, but I think the reward could be huge if the big picture for the energy sector plays out like I think it will. Today I’ll be bouncing all over the place to touch on a bunch of different topics, but I think they are all worth mentioning to try to paint a complete picture of the company.

Political Risk

The perceived political risk is the biggest reason why Petrobras is so cheap. The reason I say perceived is that I think the risk is overblown, but I wanted to start off on the topic because it is the first question in many investor’s minds when it comes to Petrobras. Luiz Inácio Lula da Silva (referred to from here on out as Lula), was elected president in November and shares of Petrobras were down by more than 30% in a couple months heading into 2023. Lula is viewed as a left-wing president, and there has been plenty of chatter on social media that Petrobras is going to get nationalized.

Brazil’s government owns 50.3% of the voting shares and approximately 37% between the two share classes (which I will talk about later). People look at what has happened in Venezuela, Chile, and Argentina and political risks there, and they assume that investing in Brazil carries the same risk. Lula has a checkered past (here’s a link to Wikipedia if you want to read up on him), but I don’t see any reason that Petrobras would be nationalized when the government is already a huge shareholder. Everyone has seen the disastrous results of nationalizing natural resource assets in Venezuela and Chile, and I don’t think we see a repeat of it in Brazil.

The government does have significant influence over energy policy in Brazil, and by extension, Petrobras. Some investors might not be comfortable with this, but we have seen examples of government influence over the energy sector in so-called developed markets in recent years. It is certainly something that investors should keep an eye on, but I think a nationalization scenario is extremely unlikely. The government already benefits from taxes generated by the company (here is a link to Petrobras’ tax report for Q1 for specifics) as well as the dividends paid to shareholders. I don’t think the government will kill the golden goose and cut the company off from external financial markets. Petrobras has been trading on public markets for over 5 decades and has had a US listing since 2000.

Money Flows

One of the reasons that I think Petrobras is so compelling is that there are several big picture themes that stack up in favor of investors. The first thing to talk about is Brazil and some of the financial flows I think we will see in coming years. Lula has been in charge in the past, from 2003 to 2010. Last time he was in charge the Brazilian real appreciated against the dollar (something which I wouldn’t be surprised to see over the next couple years), and EWZ went up 800% (EWZ 0.00%↑ is the iShares Brazil ETF).

Tavi Costa on Twitter

For 2023, EWZ is up 15% YTD, and at first glance, it still looks cheap. The ETF has a double-digit yield and many of the largest companies in the ETF are cheap. Petrobras happens to be 13% of the EWZ ETF, so if institutional money starts to flow into Brazil and other emerging market ETFs focused on South America, a sizable chunk of it will find its way into Petrobras.

Valuation & Financials

Petrobras trades at a discount to other oil majors, but I think the valuation is way too cheap today. The stock trades at a price/earnings of 2x to 3x depending on which website you look at, but either way, shares are about as cheap as they have ever been. Chevron and Exxon both trade over 10x earnings. It’s not a perfect comparison, but Petrobras could have huge returns even if the discount narrows to a P/E of 5x or 6x. They have also been improving the balance sheet by reducing debt consistently over the last couple years. If you think that oil prices are more likely to head higher than lower, Petrobras will be printing money and returning a large chunk of it to shareholders.

Converging Tailwinds

Markets are cyclical, and sometimes you will get multiple things that line up in your favor as an investor. Sentiment on Petrobras has been terrible over the last six months for political reasons, and oil prices were trending lower, which is why Petrobras has become very cheap. I think that sentiment is starting to turn, but it’s hard to quantify. Brazilian markets overall are very cheap, and I think this will be easier to measure as institutional money starts to flow into South America. When you factor in where we are in the commodities cycle, and look at the commodities compared to equity valuations, you are adding another reason to be bullish on Petrobras.

When you stack all those factors with Petrobras’ dirt-cheap valuation, I think investors have a lot of tailwinds lined up for the next couple years (and potentially longer). We will see how things play out, but I’m extremely bullish on Petrobras and I think investors able to comprehend the political situation can set themselves up for very attractive returns. Another cyclical factor at play is Petrobras’ role in the offshore sector. They are one of the largest players in offshore production, and they continue to grow.

An Offshore Giant

Petrobras has been investing heavily in their offshore production capacity, and they have some of the best offshore wells in the world. The company has a ton of experience with offshore and I think they are well positioned to grow their production significantly in coming years, ideally right into rising oil prices. Many other large sources of oil are seeing production declines (most OPEC countries) or slowing growth (the Permian Basin), while demand continues to grow consistently.

From Christine Guerrero’s Video Deep Diving Oil & Gas

Petrobras has 14 different wells that are flowing more than 50,000 barrels per day. This slide is from the Power Point from last week’s video of the week by Christine Guerrero. If you haven’t watched the video, you can skip to the 1:07 mark to watch the 10 minutes that are focused on Petrobras. The company continues to invest heavily in offshore, and if their current production is any indication, Petrobras likely has a bright future when it comes to offshore production.