Not financial advice, full disclaimer available here.
Just a quick note on Petrobras. The company has announced another dividend payment. The amount is 1.89 Brazilian Reals which equates to a 29% annualized yield for preferred shares and a 26% annualized for common shares, based on Friday’s close.
EQNR 0.00%↑ Equinor is Norway’s national oil company. The firm has a market cap of $87bn and expects to return $17bn to shareholders in 2023, a yield of 18%. Such distribution is possible thanks to record-high gas prices in Europe last year.
Since SEC reserves estimates are based on current economic conditions, future cash flows vary according to energy prices. The table below shows historical prices for the last 3 years.
On average, European natural gas prices have increased nearly tenfold between 2020 and 2022! Here is the chart showing the impact on reserves cash flows:
If 2022 is the bull case, 2021 the base case and 2020 the bear case, then Equinor is not cheap.
Management guidance confirms that it’s risky to extrapolate future results from 2022 performance. Their forecast is $25bn of cumulative free cash flows over the next 4 years.1 That amounts to 38% of enterprise value and a FCF multiple of 10.5. Clearly Equinor is not cheaper than Petrobras, as the matrix from last week was suggesting.
Petrobras' dividend forecast is $65bn over the next 5 years.2 And the payout ratio is 60%. This means ~$22bn of FCF per year, on average, and a valuation multiple of 3.4 on the current market cap.3
Here is the historical relationship between reserves estimates and the oil price:
Each data point stands for a year. 8 is 2008 — the price of brent crude oil averaged $97/bbl during the year, but crashed in the 4th quarter (when Lehman Brothers went bankrupt).
According to the trendline above, the value of Petrobras’ reserves should be around $120bn at 74$/bbl. Instead, PBR has a market cap of $74bn. The stock is discounting ~$50 oil, not 74. And you can see the upside in higher-price scenarios.
In terms of quality, here is the 3-year average for key return ratios (see footnotes).4
These companies are the best of best. So don’t dismiss BP and Occidental just because of the table above. There is a reason Berkshire Hathaway owns OXY. And the insurer has a pretty good track record :)
That said, 2 companies stand out: Petrobras and Equinor. In 2020, everyone had a bad year. In 2021, before the war5, Equinor was already generating much higher returns than its peer group. Only Petrobras was in the same the league. In 2022, the returns basically doubled for all the integrated oil companies, except BP.6
The risks of a European energy crisis have not gone away but the war premium on Equinor shares has. Given the strength of the business, and the momentum behind it, I think there is more money to be made on the stock and it is on my watchlist.
Petrobras’ dividend forecast is based on the low-end of the guidance stated in the 2023-27 strategic plan.
The debt level of Petrobras is conservative and the average maturity is 12 years.
The return ratios are based on my own calculations. The formula I used for return on capital employed is: ROCE = earnings before interest and tax / (assets - current liabilities). Return on equity is: ROE = net income / shareholder equity.
Before the war also means prior to any Russia-related impairments, not just lower European gas prices. There was less dispersion among companies in 2021. Yet Equinor and Petrobras already stood out.
OXY’s return on equity increased to 44% in 2022, from 11% in 2021.
Thanks for another excellent column on PBR.
When you mentioned that the PV_10 of PBR at $74/bbl price is $120B based on your linear plot, you should the present value with its EV, which is around $111B (MC of $74b plus net debt of $37B).
I believe the NPVs published by Wall Street firms significantly underestimate the asset of many commodity companies. The primary reason is they tend to use a flat or even declining future commodity price. The 3P (proven, probably and possible) reserves of some Canadian oil sands companies (such as CNQ, CVE, MEG and SU) can last 30 to 60 years. But at a flat oil price and 10% discount rate, the CFs after 25 years makes negligible contribution to the NPV. Since the CFs in distant future years receives little credit and it takes a lot of money to convert resources into reserves., many IOCs just try to keep their reserve life index to around 8-10 years.
The problem with discounted cash flow model is best illustrated by this scenario. Suppose that you bought 1 Oz of gold from me (a gold miner) at around $250 in 2000. At that time, I also had another Oz of gold that had not been mined and I decided to keep in underground too. Because my net profit margin of mining was 33%, the value of my 1Oz gold in the ground was $82.5. As you treated your gold as saving, you dug a hole in your backyard and store it underground. Then we both went to a Wall Street analyst to him to estimate the NPV for your and my gold in 2023 at discount rate of 10%. The analyst would likely have told us that your underground gold worthy $250 (assuming no storage and maintenance fees) while my ground gold would just be around $10. (82.5/1.1^22) (also assuming not maintaining fee of the mine). Both numbers were in the year 2000 dollar.
In 2023, the 10% discount rate actually works out pretty well for your underground gold, as $250 x 1.1^22 gives $2035 in the 2023 dollar, which is very close to Friday's gold spot price of $2011. However, if I use the same ratio to convert year 2000 NPV of my underground gold, it will give me only a value of ~$82 today. which significantly underestimates the present value. Even if my net mining profit margin has dropped in 22 years, say. to 25% today, my 1Oz underground gold should still be valued at ~$500. (The ASIC of many gold miners today is around $1200/Oz)
My conclusion is that the values of long duration commodity assets are often grossly underestimated.
Well done Sir. Thank You! I enjoy reading your thoughts on PBR vs whomever basically haha. Im Biased I guess.