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3 Ways to Play Petrobras' Earnings Miss

Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

On Feb. 10th Brazil's and Latin America's largest company, Petrobras (NYSE: PBR) reported earnings that were well below analyst expectations.  The consensus estimate was BR$0.69 a share and Petrobras' actual earnings were at BR$0.39.  To add to the earnings miss, Petrobras' net income was nearly halved YoY.  As a result of this performance, Petrobras has seen its stock-price lose over 8% of its value:

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The key rationale behind Petrobras' lackluster performance was two-fold.  First, analysts cited the depreciation of Brazil's Real relative to the dollar over the time period as a major factor.  And second, the balance sheets demonstrate that the intensive capital spending on account of the difficulty extracting oil in offshore "pre-salt" regions ultimately negated the company's ability to generate a 20% increase in YoY sales.  

Earnings misses can provide buy-and-hold investors with decent entry points however, especially if the underlying business fundamentals that have been profitable in the past can be profitable again in the future.  Also, because the specific reasons why Petrobras struggled deal with issues that can be remedied through Brazil's government and other companies, savvy investors can play these areas to profit off of the company's future-plans.  The remainder of this article will highlight three such investing strategies: the front-door approach, the back-door approach, and the intangible approach.

The Front-Door Approach

The front-door approach is quite simple really.  Because Petrobras has been profitable in the past, and because Petrobras has rights to copious oil reserves, the company should regain its former levels of profitability assuming that the demand for oil remains constant.  Thus, investors may be wise to purchase shares during the undergoing sell-off.  

Investors utilizing this approach are in fine company.  Famed buy-and-hold investor Warren Buffett is a champion of the front-door approach, he has purchased companies such as Goldman Sachs and General Electric following earnings misses utilizing the rationale of a future return to historic earnings performance for each company.  

As stated previously, Petrobras stock has lost over 8% of its value since its earnings announcement, and the overt focus on earnings and revenue alone have allowed many analysts to skip over the company's stellar reserve-replacement ratio of 148%.  This means that Petrobras found more oil and gas than it produced, so it should be able to meet Brazil's increasing energy needs to a greater extent in the future.  

Everything considered, I do not believe that Feb. 15th Petrobras is actually worth 8% less of Feb. 9th Petrobras; the company still utilizes an effective integrated model, and it is developing an extensive infrastructure that once fully developed should extract, produce, and sell an increasingly larger percentage of oil to Brazil and other emerging Latin American nations over an extensive time period.  Yes, as the company has grown, the company has seen its profits shrink.  But, exogenous variables such as rare oil-price differentials and currency fluctuations seem to be causing Petrobras' ills, not its model.

The Back-Door Approach

As stated above, substantial capital expenditures were a major reason why Petrobras was unable to provide earnings hungry investors with estimate beating figures.  Petrobras should continue to fork over massive sums in the foreseeable future because the area in which it operates presents numerous challenges:

  • The largest reserve estimates are offshore so the company has to buy rigs and other materials.
  • The offshore region of Brazil where the oil has been found is much deeper than other mainstays such as the North Sea or the Gulf of Mexico.
  • The oil produced in this region is heavy and most of Petorbras' refineries cannot handle it.

Considering the above, one company, National Oilwell Varco (NYSE: NOV), stands apart from the crowd as a major potential beneficiary of the situation.  National Oilwell Varco designs and manufactures rig equipment, and an estimated 9 of 10 existing rigs utilize its parts.  Petrobras recently ordered 26 rigs; 21 with Sete Brasil and another 5 with Ocean Rig.  Since National Oilwell Varco supplied Sete Brasil with 100% of its parts from a prior order of 7 rigs from Petrobras, analysts at Morningstar have penciled the company in for a repeat arrangement this time around.

To add to the boon from Petrobras, National Oilwell Varco currently has a backlog of about $10.2B and S&P predicts that number to grow to $11.5B by years end.  These figures represent the strong overall demand for National Oilwell Varco's products.

The Intangible Approach

The intangible approach is the riskiest way to play Petrobras' recent earnings miss because an exponentially greater number of variables can effect outcomes regarding this strategy.  Simply put, this strategy involves either buying Brazil's currency, the Real, or a Real tracking ETF such as Wisdom Tree's Brazilian Real Fund (NYSEMKT: BZF).  

You may be asking, "what does this strategy have to do with Petrobras?" and the answer lies in the interests of the Brazilian government.  Currently, about 10% of Brazil's GDP stems from its oil sector, and former president Luiz Inacio Lula da Silva is on the record stating that he believes that number will grow to 20% in three years.  

Focusing on Petrobras, the Brazilian government owns about 54% of its common shares, and two state-owned entities, the Brazilian Development Bank and Brazil's Fundo Soberano own another 5% each.  This brings the state's ownership of Petrobras to 64%, so major international sell-offs are not in its best interests.  

Since many analysts have cited the weakness of the Real as a major factor in Petrobras' recent earnings miss, the Brazilian government can go on the offensive in order to appreciate its currency.  Despite the incentives however, there are a large number of factors that can keep Brazil's government from taking any initiative to appreciate its currency.  

It deserves to be restated though, that Brazil's GDP is becoming increasingly reliant on the oil sector, Petrobras is the largest company in that sector, and it is majority owned by Brazil's government.


Motley Fool newsletter services recommend National Oilwell Varco and Petroleo Brasileiro S.A. (ADR). The Motley Fool owns shares of National Oilwell Varco. maxwellkirchhoff has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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