(Des)Ordem E Progresso
This Petro-Bro Is Back In Brasil
O Brasil é o país do futuro, sempre foi e sempre será
- Brazil is the country of the future, always has been and always will be.
Welcome back to the ROI club.
Brazil’s currency, the real (BRL) is down 20% this year and sits at historic lows against the USD as seen below.
In a nutshell: The market hates Lula and is basically afraid he’s going to ‘pull a Chavez’ and turn Brazil into Venezuela.
Spoiler alert: Not likely to happen.
My take: Latest announcements that the national budget won’t deliver a surplus but rather a 1% deficit has resulted in stocks sold off like a Brazilian baby with the bathwater and provide a nice entry point for patient investors who understand yield.
Aside from war, hyperinflation or societal collapse, a yearly move that big is simply not suppose to happen in the world’s 8th largest economy.
Argentines, who prior to Milei, are used to their peso devaluing by 100%+ year on year, are celebrating the fact that it’s now much cheaper to holiday in Brazil than inside Argentina - below.
After years of being on the other end of this type of ribbing, Argentines are relishing ‘hinchando las pelotas’ of their neighbouring big brother.
I myself am organising a trip to Brazil in 2025.
Vacation plans aside, Brazilian stocks have been such a disaster that even my good friend
is de-gringoing and looking for big, fat, round, juicy, Brazilian… bargain stocks. Listen to our latest chat as we discuss why the US dollar’s recent strength may roll over in 2025 and provide a big tailwind for foreign stocks, which would benefit Brazil.The BOVESPA is down 23% YTD with the equities I care about as follows:
PBR -0.65%
Vale - 31%
PAGS - 37%
BAK - 40%
I own PBR and PAGS currently and am most familiar with those names having owned them in various sizes over the last 2-3 years. You can find my takes on each in this sub stack’s archives and on my youtube channel.
My take on all of the above is coming over the next few weeks, including some options trades offering riDONKulous income opportunities for those looking to generate some extra cash.
Starting with the crown jewel of Brazil, Petrobras, today I leave you my updated take on what I think it’s worth and how I’m positioning my investment, along with an option trade that offers me a 39% cash return up front.
Let’s dig in.
Investment Idea: Petróleo Brasileiro S.A. NYSE: PBR or PBR.A
Executive Summary:
Petrobras explores, produces, and sells oil and gas in Brazil and internationally. The company operates through Exploration and Production; Refining, Transportation and Marketing; and Gas and Power.
Petrobras dominates offshore E&P and is proud of their hydrocarbon business stating their aim to be in the top 5 producers worldwide by 2030
Investment Thesis:
The king of offshore growth. CAPEX and shareholder returns. Ample reserves insitu with an organic replacement rate of 168% LTM provides return of profits to investors without compromising the future. Dividend yield of ~10% expected with overall break even rate of $35/BBL implying limited downside. Investors can conceivably use the high yield + options market to conceivable lock in 15%+ returns over the next 2 years.
Reserves:
11 Billion BOE = 10x years of stay flat production Vs Current MC/FCF <5x
i.e: Today’s price implies an investor makes their money back in roughly 5 years and enjoys the rest of the profits from production for free.
My Notes:
Fears over ‘nationalisation’ abound. Actually, the Brazilian government already owns the majority of the shares and relies on the dividend to fund its social rents (effectively it already is nationalised).
PBR increased 11x during Lula’s previous presidency and yes, that was on the back of an epic bull run where oil rose 400%. The point is more that not even Lula can ruin PBR (At least not yet).
Valuation:
To value a super major like this one it’s easy to get lost so I’ll keep it elegantly simple with the aim of getting it ‘roughly right’ as opposed to 'precisely wrong’.
The key components are: how much product can PBR produce, at what price, how much will it cost to produce and operate the business and how much of the profits will be returned to shareholders?
USD will be kept constant throughout and any favourable change back to a ‘normal’ BRL/USD cross rate will be considered a bonus.
Production in 2024 has been steadily around 2.7 MBOED and is expected to grow at 3% over the next 5 years thanks to their exploration in their offshore pre-salt territories.
An overall price of $85 BOE is analysts estimate for 2024.
Their EBIT and free cashflow (FCF) margins have averaged 23% and 14% respectively over the prior 2 decades and impressively, their ROE track record is 17.11% over the same period. Despite the fact that this business model is usually way too capital intensive for my liking, management have racked up ROE numbers slightly ahead of the best-in-class, XOM (16.07%).
Putting together a sketch of my estimates of the next 5 years I think that in a flat, base case, PBR can easily ave 3 MBOE at $85 BOE realised. Using 14% FCF margin that’s approximately $13.4 Billion in free cash on today’s MC of $87.5 Billion or a 15% FCF yield.
The company’s target is 3.2 MBOE and at $95 BOE. This implies:
The company earns back its entire market cap in less than 6 years and dividends of $1.12 per year on average per ADR or ~8.8% yield.
Whilst perhaps decent for some, this alone is not enough for me to buy the straight equity. However, PBR is a nice options vehicle and I see some plays that offer me a way to juice that yield up to as high as 39% and significantly reduce downside.
This is the sort of play I’ve been milking for years and allows me to live The Maverick Life of adventure with geographically independent income stream.
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