The South American Sleeping Monster

10 Best Warren Buffett Stocks To Watch Right Now

My advisor during college was the son of a retired Brazilian military official. Before turning to academics he was an advisor for the Brazilian Ministry of Foreign Relations. Surely the man lacked no patriotism for the country that educated him. However, he displayed a great deal of doubts over the country´s prospects for growth when dubbing the country as "The Sleeping Monster of South America." Repeatedly he warned about the time when the country would awake. Meanwhile, one had to stare at the inefficiently used and abundant resources. A similar opinion deserves the country's oil & gas company, Petroleo Brasileiro (PBR), or Petrobras. In other words, amid recent reserve discoveries and capital investment, and after a small recovery, stock value has returned to 2007 crisis levels. Why then does Brian Rogers (Trades, Portfolio) continue to acquire the stock?

A Developing Company

There are no doubts about the capital growth of Petrobras. Reserve discoveries off the cost of Brazil have abounded in quantity and quality, which have impacted total oil and gas output thanks to the addition of new wells. At the same time, the company has made important acquisitions like Pasadena refinery. Most importantly, new producing platforms have been added to the current fleet, exemplified by the coming into operation of the P-58 platform last March.

Petrobras has successfully integrated its production business from exploration to distribution. It owns all the assets required to depend from no one, and operate an efficient through downstream operation. Most importantly, management continues to separate capital for investment, and is expected to spend a total of $153.9 billion by 2018.

An important share of those funds, are to be destined to the development of new technology by Petrobras. The most interesting ongoing projects are focused on improving floating processing storage and offloading units, autonomous underwater vehicles, submarine processing units and power distribution systems, and rise-free drill units. Success of these developments have the power to change the way in which deepwater oil production is done.

Last, Petrobras has set five monthly processing and production records, as well as three records in diesel and gasoline production during 2013. However, the company is looking forward to produce more and seek new products. Management is aiming to lift production from current 2 billion barrels per day to 3 billion. For the same reason, technology developments are all the more important.

Financially Unsound, and Lacking Prospects?

Petrobras has financially reached a ceiling. For the third year in a row, revenues and net income have registered a small decline. During the same period, cash flow deteriorated while debt has risen considerably. Most importantly, operating margin has been slashed down to 11%, far from the levels recorded for the past decade.

The deteriorating performance of Petrobras is deeply related with domestic policies that limit profitability. That is the greatest downside to the firm, the absence of international exposure, because it does not allow the firm to curb the sacrifices done at home. Another downside is the depth at which reserves are found, making the projects uncertain while bearing a great financial risk.

Currently trading at 7.1 times its trailing earnings, Petrobras trades at a 40% discount to the industry average. Although quarterly and special dividends do not make the stock attractive, the know-how and ongoing technology projects are the key to future growth for the company. Additionally, the company almost single handedly serves one of the fastest growing emerging markets.

A positive sign for a long-term investment on Petrobras would be an easing of governmental pressure over profits. However, this is not expected to happen until the end of the FIFA World Soccer Cup. Brian Rodgers has confidence that an important change in policy will prove his early investment correct. But smaller investors looking for a long-term investment are recommended to wait for a firm decision by Brazilian authorities after June.

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

About the author:Vanina EgeaA fundamental analyst at Lone Tree Analytics

Visit Vanina Egea's Website

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