Will Vale and Petroleo Brazileiro Rebound From Brazil's Ills?

Brazil's mega-companies have been hit by a steep slide in the country's economy. With a potential for improvement in the fortunes of both the country and the companies, is it time to buy Vale and Petrobras?

Feb 27, 2014 at 4:00PM

Think back about five years, and you'll likely recall that Brazil's integrated oil company Petroleo Brasileiro (NYSE:PBR), or Petrobras to most of us, and its minerals miner Vale (NYSE:VALE) were largely considered the creme de la creme among companies domiciled in the BRIC nations. But then their country's government and economy figuratively skidded down a steep embankment, dragging the two companies' valuations with them.

Source: Wikipedia Commons.

While you're thinking retrospectively, you might also remember that, during the previous decade South America's largest country was the epitome of an optimistically viewed developing nation. That status wasn't hindered by the 2007 discovery of the giant Tupi field in the deep pre-salt waters of the Santos Basin.

Brazil's economic potholes
Nor was a 7.5% economic growth rate in 2010 at all problematic. But a host of other factors -- like excessive public sector spending, bottlenecks created by infrastructure insufficiencies, overregulation, corruption, and a dearth of skilled workers -- have tromped the country's growth to the meager -- albeit still estimated -- rate of 0.3% for the most recent quarter, perilously close to being recessionary.

Simultaneously, Petrobras has tumbled from a five-year high near $50 a share (it had topped $70 shortly after the Tupi discovery) to a current level below $12. For its part, Vale, the world's largest producer of iron ore, skidded from more than $35 per share in early 2011 to a current level near $14. While I don't see either company returning to its prior levels in the short term, it also seems that both have suffered more of a valuation shellacking than was appropriate.

Propellers for Petrobras
And lo and behold, there are a few emerging bright lights in Brazil's future that could at least psychologically boost the esteem in which its major companies are held. Later this year, for instance, the World Cup will be held in the country. And the next time Olympic Games are conducted, in the summer of 2016, Brazil will serve as their host. Beyond that, the International Energy Agency expects the country to triple its oil production during the next couple of decades. That final prognostication obviously will do wonders for state-controlled Petrobras.

Beyond that, it's important to note that the company is hardly confined to its home country. Indeed, its operations can be found in 25 countries, including the U.S. Gulf of Mexico, where it has become a major player. In that venue, as my Foolish colleague Arjun Sreekumar told you earlier this month, it holds a 25% interest in the big St. Malo field (among others), in which Chevron (NYSE:CVX) is the operator and holder of a 51% interest. With Chevron targeting the deepwater Gulf for increased activity this year, Petrobras could well be a beneficiary.

From a purely valuation standpoint, let's compare Petrobras to Norway's Statoil (NYSE:STO), another comparably sized, state-controlled international player. While the Brazilian company's trailing P/E ratio is about six times, Statoil's is twice as high. And yet, Petrobras sports a PEG ratio below 0.50, indicating expectations of substantial growth for the company in the coming years. Statoil's is twice as high, evidence of far less sanguine forecasts.

Vale's excessive valuation shortfall
Vale, in addition to its supremacy in iron ore -- a key ingredient in the manufacture of steel -- also produces a variety of minerals and metals that include nickel, fertilizers, copper, coal, manganese, cobalt, platinum metals, and precious metals. Its operations occur both in Brazil and in a variety of international locations.

Much of Vale's financial success depends upon iron ore demand and prices, which in turn are substantially at the mercy of construction levels and other manufacturing and infrastructure activities in China. Ore prices actually rose during 2013, only to dip as this year began, and the jury remains out about their likely direction as 2014 progresses.

In the meantime, Vale's trailing P/E sits slightly above 15 times, versus nearly 29 times for Rio Tinto (NYSE:RIO), a slightly larger, but otherwise comparable Anglo-Australian minerals producer. That significant disparity exists despite Vale's 33% operating margin, compared with slightly more than 27% for Rio. And what's more, Vale's 5.3% return on equity dwarfs Rio Tinto's 1.9%.

The Foolish bottom line
There are other substantial international companies headquartered in Brazil. But for now the potential for a brightening picture in the country and the apparent undervaluation of both Petrobras and Vale are well worth Foolish observation.

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David Smith has no position in any stocks mentioned. The Motley Fool recommends Chevron, Petroleo Brasileiro S.A. (ADR), and Statoil (ADR) and owns shares of Companhia Vale Ads. 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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