Politics Creates Opportunity For A Double In Petrobras: Part II

Forbes September 26, 2014 0

Last month, Mike Koza told us why he believes that politics in Brazil, has created an opportunity for Petrobras (NYSE: PBR) to double in the next few years.

Last month, Mike Koza told us why he believes that politics in Brazil, has created an opportunity for Petrobras (NYSE: PBR) to double in the next few years. Since current polls show that Socialist Marina Silva has pulled ahead of President Dilma Rousseff, Mike’s thesis seems to be on track. In spite of Silva’s history as a “Green” candidate, she has shown a more business friendly attitude toward commerce. Mike believes the election of a more business friendly President could be the catalyst for a double in Petrobas.

Mike’s Marketocracy track record shows an annualized return over the last 10 years of 18% with an investment style similar to Warren Buffett’s. Berkshire Hathaway and the S&P 500 both show annualized total returns just short of 9% during the same period.

You can view Mike’s top five holdings, learn more about his strategy, and track his progress with monthly Performance Insights emailed directly to you at the end of each month by visiting our website.

One of Mike's holdings is Petrobras. His Marketocracy model portfolio has averaged 18% a year for the last 10 years. (Photo Credit: Bigstockphoto)

One of Mike’s holdings is Petrobras. His Marketocracy model portfolio has averaged 18% a year for the last 10 years. (Photo Credit: Bigstockphoto)

This month, we sought feedback from our Marketocracy community to flesh out Mike’s thesis. Even Master Marcus Eder weighed in with an opinion. The opinions were divergent, and that was no surprise. Half of the PBR holdings among our members are held by those in the lower quartile, but the top 25% of our members have recently started increasing their positions. For those who own Petrobras, we have these opinions.

Bruce Carroll, a member since 2001, says, “With a P/E of 12.9 and selling below book value (P/B is 0.71), it is a compelling value. Add in a PEG Ratio of 0.57 and you have a Growth at a Reasonable Price (GARP) investment.” He also warns, “It does have a low Altman Z-Score of 1.69, so it is in the danger category. If that falls further and it misses more production targets it might be time to sell or at least take some risk off the table.” I asked Bruce about the political environment, he finished by saying, “I do not think that a change in the political environment is enough to lift PBR. It will help, especially if the political changes mean that PBR will no longer have to sell gasoline below cost.”

David Robertson, who has averaged 16.75% since 2004, adds, “I like the fact Brazil is oil independent and PBR’s P/E ratio. It works as a diversified position as an international position. Is it better than Exxon? No. Does it belong in everyone’s portfolio? No. Is it poised for better days? Most likely. Look, the stock is down from previous years, but held over the long term it should do well.”

Calvin Rose says, “We use algorithms to select stocks to buy and to sell. PBR performed in a way that triggered our algorithms to buy it.” Calvin has averaged 9.58% since the beginning of 2008.

I had a great conversation with Basher Abdul whose performance since October 2000 has been stellar with an average return of 8.84% compared to the S&P’s 4.97%. Basher gives us this:

Petrobras will be better once the October election is over. Regardless of who wins, an increase in oil production would help PBR and make up some of the losses from fuel imports. Currently, I am holding 10% of my portfolio in PBR, and it has returned 32% so far.

I asked Basher if there were some numbers that caught his attention.

The revenue growth has slightly outpaced the industry average of 3.0%. Since the same quarter one year prior, revenues have slightly increased by 3.8%. This growth in revenue does not appear to have trickled down to the company’s bottom line, as displayed by a decline in earnings per share. Compared to where it was 12 months ago, the stock is up.

Basher does provide some caution, though:

The gross profit margin for Petrobras is currently lower than what is desired, coming in at 32.09%. It has decreased from the same quarter from the previous year. Along with with this, the net profit margin of 6.02% trails that of the industry average. Additionally, the net operating cash flow has decreased to 18.05%.

I asked Basher how he felt about the political environment in Brazil:

PBR is dealing with the investigation into allegations that government officials took bribes linked to Petrobras contracts. Many of these officials are in Dilma Rousseff’s party. The speculation is that a new government would come in to support growth. Perhaps they can offer new benefits to industry. At least that is what Marina Silva is saying when she says she wants to bring investors back to the country. We’ll see.

Stanislav Drastich has been a member since 2008, and offered why he likes PBR. Even at that, he is willing to wait:

PBR has incredibly high growth potential. It might happen that it will grow to $140-$160 per share in the next 8 years. However, at the moment, it is still technically falling down. I do not believe, that it is the right time to buy or extend existing positions. Actually I have no PBR shares in any of the virtual funds I manage. If you review the current situation, the graphs seem to be little bit optimistic. Just review all time history and you easily find that overall trend is bearish for PBR. I do not reject to follow the bearish shares if there is a good possibility to switch to bullish trend at a feasible time.

Stanislav provides a good segue to those who caution against buying Petrobras.

Some of our members, like Lisa Turner (member since 2001) and Thomas Teaster (member since 2004) just simply stay away from emerging markets. Lisa says, “I prefer U.S. companies. Government stability is always my main concern.” Thomas agrees, “I try to avoid putting my money in places that are still infected by leftists intervention in free markets. Granted that has cost me money in places like Brazil and China, but I have to sleep at night.”

Joe Soraghan (member since 2003) adds that volatility was a major concern, “I no longer own PBR in real life for several reasons. First and foremost, it was a manic stock, and they tend to correct 80% from peak. Second, China is slowing down, the U.S. is barely growing, and Japan is asphyxiating slowly. This is not an oil positive climate.”

Thomas Pound, whose Energy and Utilities Fund has averaged 13.58% (v. S&P 500’s 8.92%) feels there are better opportunities elsewhere. “I personally own Helmerich and Payne (NYSE: HP). I guess if one wants a play in emerging markets, then they should look at CNOOC (NYSE: CEO). Petrobras just doesn’t fit into my rubric for me to want to buy it. I think there is some intrinsic value where it might grow to $35 per share, but it is not a risk I want to take with mine or someone else’s money.”

I was about to wrap up my work, and then I heard from Marketocracy Master, Marcus Eder. Marcus is a true all-star, and we value his opinion. Since 2001, he has averaged 17.55% compared to the market’s 6.10%. This kind of superior performance has repeated itself for one, two, three, and five year periods.

You can view Marcus’ top five holdings, learn more about his strategy, and track his progress with monthly Performance Insights emailed directly to you at the end of each month by visiting our website.

This is what Marcus provided us:

In my opinion, PBR is not too efficiently managed, and there is way too much political influencing. If the “Green” candidate for president, Silva, wins the upcoming election, then all resource plays in Brazil might be affected.

Apart from this, PBR is clearly a major “bigcap” stock with a market cap of $115 billion. Such firms tend to move in lower percentages than their smaller competitors.

I asked Marcus on which numbers was he focusing for PBR?

Valuation wise, PBR is not too expensive, but it’s not too cheap either. The EV/R (Enterprise Value to Revenue) at 1.50 is decent, but EV/EBITDA at 7.50 is not low at all.

I asked Marcus if he likes the oil sector?

If I don’t like a sector, I stay away. If I like a sector, I buy firms where the upside is higher than in the major players. Oil prices are not too strong these days, most probably because world economic growth is not up to potential. I think the ECB’s stance is deflationary. That is just my opinion. On the other hand, upstream oil is a “call” on economic improvement AND mending of Russian ties. There are rumors that the West have persuaded the Saudis to open their spigots to depress WTI and Brent by roughly $10-15. With Russia’s budget revenue so much dependent on raw material, prices, especially oil and gas, they could face an induced recession.

So, Marcus, should we invest in the oil sector?

Apart from this caveat, I’m slightly bullish on the sector. I’m a firm believer that now is the time to get rid of U.S. “defensive” areas and get into more cyclical plays domestically and into those firms across the glog which are cyclical and serve a world market.

What oil sector companies have caught your attention?

In the region, if I wanted to invest in a “State oil company,” my money would be with Colombia’s Ecopetrol (NYSE: EC). See, my specialty is smallcaps, so EC is a little too big for my tastes. I have a position in GeoPark (NYSE: GPRK) based in Chile and operating in Colombia, Brazil, and Argentina. It fell out of favor, but I will withstand short-term losses. I also like TransGlobe Energy (NASDAQ: TGA) based in Canada, but operating in Egypt and Yemen. I know I have to be patient with these, so I will give them time to grow.

My Take:

I trust both Mike and Marcus, even though they have different opinions about Petrobras. First, both have proven track records that show their skill and knowledge. Second, they both see opportunities in emerging markets when it comes to the oil exploration sector. Together, they provide a diversified approach if one wants to find stocks that can potentially double in the next few years. This is why they, along with Justin Uyehara and Kai Petainen, make up my Marketocracy Explore Team; to provide a team of proven investment managers that can work for our clients. While their portfolios do not overlap, this approach allows for improved diversification in the strategy among investment styles, sectors, and market caps. The result is a portfolio that is aggressive but also diversified.

Connect with Ken Kam on LinkedIn.

Disclosure: I am the portfolio manager for mutual and hedge funds advised by Marketocracy Capital Management, an SEC registered investment advisor. Before relying on the opinions expressed in this article, you should assume that Marketocracy, its affiliates, clients, and I have material financial interests in these stocks and may hold or trade them contrary to these opinions when, in our view, market conditions change.

Article originally posted in Forbes website.