Petrobras: A Bargain-Buying Opportunity After Post-Election Sell Off

Brazilian President Dilma Rousseff, a Marxist-leaning liberal, was re-elected by a narrow margin over rival Aecio Neves, a pro-business candidate. But the defeat was really suffered by investors in the government-regulated Petroleo Brasileiro Petroleo (NYSE:PBR), which crashed 14% the session following the election. The bleak sentiment around the largest-publicly traded South American oil company makes for a great contrarian buy. Bargains don’t come around when optimism runs wild.

Petrobras’s price-to-earnings ratio of 9 undercuts the oil and gas industry’s P/E of 11. Its price-to-book ratio is only 0.5 and deep under its five-year average of 1.4 and the industry’s P/B of 1.3. Its 0.6 price-to-sales ratio is also far beneath its five-year average of 1.2.

Petrobras shares have plunged 31% in the year through Oct. 28 in the face of declining oil prices. Moody’s lowered its debt-rating because of high debt levels. Net debt amounted to 40% of net capital, as of June 30. The stock has already priced in the bad news, analysts say.

“We think an extremely negative environment is already discounted in the share price,” research analysts Vicente Falanga Neto and Frank McGann at Bank of America Merrill Lynch wrote in a client note Oct. 24. “Petrobras has one of the strongest fundamental investment cases among global oils, which should continue to support further strong stock price appreciation.”

Among the many things Petrobras has going for it are “(1) strong production growth momentum, (2) additional expected announcements related to ongoing exploration work in Brazil, (3) new projects coming on stream in its international units, and (4) expected improvements in perceived country risk in Brazil,” Neto and McGann wrote.

Petrobras is trying to cut costs by $8 billion per year over the next four years as oil output is projected to rise because of improved operations and new projects in the Campos Basin, according to Allen Good, an analyst at Morningstar. Brazil’s total reserves could triple thanks to discoveries off the Brazilian coast. Petrobras wants to add, over the next 10 years, 1.5 barrels a day in refining capacity.

“With nearly all of Brazil's refining capacity and investments to increase diesel production, Petrobras can capitalize on the growing domestic demand for refined products,” Good wrote in a client note dated Oct. 24.

A major risk that investors should consider is that the investments in new refineries may not be as profitable as expected because of the government-controlled oil prices and cost overruns, Good wrote.