It’s been a rough run for Brazilian state-controlled oil giant Petroleo Brasileiro Petrobras SA (ADR) (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 more than $70 per share in mid-2008. PBR stock now trades for barely one-tenth of that value and can be had 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. Brazil’s President Dilma Rousseff is … ahem … 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 belief that Rousseff would lose re-election. And most of the brutal bear market that has endured since has been a result of her expected (and realized) re-election.
Rousseff has not been implicated in the kickback scandal, though dozens of congressmen from her party have. She was chairwoman of PBR’s board for seven years, until 2010, but has said she had no knowledge of the alleged corruption.
Petrobras lost more than $44 billion during Rousseff’s first term by selling fuel at below-market prices. A cynic might say she forced Petrobras to keep retail gasoline prices low as a way of buying votes for re-election. (And yes, count me as a cynic in this case.)
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 Corporation (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 break-even price for Brazil’s offshore fields at more than $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 that 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 six times expected 2014 earnings and four times expected 2015 earnings. It also trades for an almost pitiful 0.37 times book value and 0.4 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.
The Bottom Line
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 selloff.
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.
Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.
