Petrobras: Brazilian Oil

Wednesday morning's research comments included this nugget from UBS Securities' Latin American analysts: They called Petrobras (symbol PBR) "very appealing at today's price." The stock was at $76 before the market opened and after a strong day all around, closed at $80. But that's still far below the $100 that Brazil's national oil company, officially called Petroleo Brasileiro, traded for just eight weeks ago. Given that the shares of other large, integrated oil companies haven't been hit anywhere as hard, it's worth looking a bit more deeply into the biggest company in the land of the current -- and, presumptive, future -- World Cup soccer champions.

Petrobras trades as an American depositary receipt on the New York Stock Exchange, so the shares are easy to buy and sell. It uses the U.S. dollar in its financial statements, so its earnings reports and balance sheet are easier to understand than those of the typical Brazilian business. But Petrobras isn't just a foreign version of Chevron or ExxonMobil. It does most of its refining and marketing business in Brazil, so its fortunes are tied directly to the Brazilian economy. Petrobras produces and imports large quantities of oil and gas from Bolivia and Venezuela, whose governments are trying to wring more tax and royalty money out of Petrobras. Petrobras is also a player in Brazil's efforts to use sugar cane and other biofuels to run cars and trucks and reduce its reliance on imported crude oil.

In sum, you need to weigh three issues to assess this company. First is the outlook for and the value of large oil-and-gas companies. The second is Brazil's prospects. And the third concerns issues peculiar to Petrobras. Let's look at each.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

First, the prospects for energy stocks remain bright. Barring a worldwide recession that slashes demand for oil, the price of crude is unlikely to plunge. Too many gas-guzzling cars and strong demand from emerging nations -- China being the most prominent -- ensure steady demand. And there's always the chance that hurricanes or, simply, fears of hurricanes, could push prices higher. Oil-company stocks are reasonably valued, and the industry has loads of cash.

Investing in Brazil is riskier than investing in most developed nations. As one the of most prominent "emerging markets," Brazil's stocks are known for swinging wildly, often because investors buy or sell the entire country or emerging markets in general. Petrobras is 25% of the MSCI Brazil index, so you'll always see a lot of action in its price, regardless of country-specific or industry-specific developments. The exchange-traded iShares MSCI Brazil Index fund (EWZ) is down 17% the past three months but is still up 40% for the past year. Meanwhile, the Brazilian economy is sound, with exports up so far in 2006 over 2005 and the real, its currency, strong against the dollar.

Petrobras itself has a lot going for it. It has enormous energy reserves, $10 billion in cash, and -- here's a wild card -- some appeal if you would like to invest in a big oil company but find "green" issues are important. This week, Petrobras announced a program to make a fuel that's a combination of diesel and vegetable oils. It's already a leader in ethanol fuels.

A more critical issue is the outlook for Brazil's economy and currency. Petrobras figures its earnings by translating profits from Brazilian reais (plural of real) into U.S. dollars. It also borrows in dollars. The real now is strong, but if it were to reverse course, Petrobras's dollar earnings would fall sharply and its debt would also become a burden. That would be ugly for the stock. But a fresh report from the Sao Paulo stock exchange argues persuasively that Brazil's economy is strong and not about to fall off a cliff.

At $79, the stock sells for less than seven times the average analyst earnings estimate for 2006 of $12.36 per share, according to Thomson First Call. That's a low price, even allowing for an emerging-markets discount. Petrobras shares clearly took some losses in recent weeks because of the political fight with Bolivia, but that's off the front pages for now. In short, Petrobras may not be right for every investor, but it certainly seems like a good bet for those who can tolerate the risks of investing in a single emerging-markets stock.