It’s been a rough run for Brazilian state-controlled oil giant Petrobras(NYSE:PBR). The stock has been in almost continuous decline since late 2009 and its U.S.-traded ADR has lost nearly two-thirds of its value since July.
This is a stock that was trading at over $70 per share in mid-2008. It now trades for barely one tenth of that value; the Petrobras ADR now trades at 2004 prices. It’s as if the massive mid-2000s bull market in Brazil and the rest of the emerging markets never happened.
So, what’s the story here? Why are investors giving Petrobras such a thorough thrashing?
It’s a long list, but I’ll start with the most pressing. Petrobras is engulfed in a nasty corruption probe that alleges the company systematically overpaid for assets and labor and that the proceeds were used by the government to give kickbacks to prominent politicians in exchange for votes. It’s so bad that Petrobras had to delay its third-quarter earnings release because its auditors refused to approve them.
This brings me to the second reason for Petrobras fall from grace: Dilma. Brazilian President Dilma Rousseff is not known for being friendly to business. Much of the massive bull run in Brazilian stocks during the first half of the year was based on the believe that Dilma would lose reelection. And most of the brutal bear market that has endured since has been a result of her expected (and realized) reelection. Dilma herself has not been personally implicated in the kickback scandal, though dozens of congressmen from her party have. Dilma’s real damage is not due to corruption, however, but her preference for using the company as an instrument of the state.
Rather than allow Petrobras to be run like a normal, for-profit business, she has used it as a social policy tool. A cynic might say she forced Petrobras to keep retail gasoline prices low as a way of buying votes for reelection. (And, yes, count me as a cynic in this case.) Unfortunately for Petrobras shareholders, politics trump economics.
With profitability crimped by price controls, Petrobras has had to borrow heavily in order to fund capital expenditures. Petrobras is the most heavily indebted energy company in the world, with $106 billion in long-term debt. To put that in perspective, Exxon Mobil (NYSE:XOM) – which is eight times larger than Petrobras by market cap and three times bigger in terms of annual revenues — has only $12 billion in long-term debt.
And finally, while Brazil is now a major energy player, its largest reserves are located in deepwater fields that are expensive to exploit. One estimate puts the breakeven price for Brazil’s offshore fields at above $120 per barrel. With the price of crude now hovering at about half that price, Petrobras’ greatest assets are essentially unexploitable.
Political corruption, a president who views the company as a piggy bank for social policies, a high debt burden, and massive quantities of oil that are too expensive to exploit at current market prices — no wonder investors have dumped Petrobras. But is the selling overdone? At current prices, Petrobras trades for just 6 times expected 2014 earnings and 4 times expected 2015 earnings. It also trades for an almost pitiful 0.37 times book value and 0.41 times sales.
Any way you slice it, Petrobras is cheap. But if the last several years in Brazilian stocks has proven anything, it would be that cheap stocks can always get cheaper. Right now, Petrbras is a proverbial falling knife that I wouldn’t recommend you try catching with a large purchase just yet. Though I would recommend you consider averaging into the stock slowly over the next several months.
Petrobras is a stock that can move fast. It doubled in value between March and September of this year before giving up all of those gains and more in the sell-off. Buying it today, at decade lows, would likely be a fantastic entry point for a three- to five-year investment time horizon. Just expect it to be a wild ride in the meantime.
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