While earnings are critically important to investment success, they are only half of the equation. Companies can exercise some control over their earnings growth, but the other half of the equation -- valuations -- are the bailiwick of the market.
In the case of Brazilian energy behemoth Petrobras (NYSE: PBR), there seems to be a bit of a disconnect between the quality of the company and the market's estimation of the company's worth. Petrobras trades at less than 10 times trailing earnings -- well below the peer average of 15 and below comparable companies like Total (NYSE: TOT), Royal Dutch (NYSE: RD), or PetroChina (NYSE: PTR).
So the question then becomes, why?
Like most other large energy companies, Petrobras reported strong results for the fourth quarter. Net revenue climbed 20% and net income rose 51% as higher energy prices boosted results.
So far, so good.
Part of the trouble, though, is that production for the quarter was up only 1% and was clearly well below the company's past double-digit production rates. Although Petrobras is looking for double-digit production growth next year (which is huge for a company this size), the market seems to be a bit skeptical about management's ability to follow through.
There are also concerns about the company's refining operations. Given that most of the crude oil produced in Brazil isn't suitable for the company's refineries, they must import a great deal of oil. Considering the high prices of oil and oil shipping of late, it's no surprise, then, to see refining margins under pressure.
Debt is also a major issue for Petrobras, as its long-term debt-to-equity ratio is far above the industry average. What's more, much of Brazil's oil is in deep water or ultra-deep water regions, making it more expensive to lift out of the ground.
Brazil itself is something of a problem as well. Its government has a major stake in Petrobras and has been known to run the company for political advantage as opposed to shareholders' economic advantage. What's more, the Brazilian economy has had crushing bouts of inflation in the past, and many investors remain skeptical about the country as a whole.
So is there anything to like about Petrobras? Over the long haul, yes. The company should be able to ramp up production to a level that will put other major producers to shame. It also has a 25% higher reserve-production ratio than its peers -- meaning its current production is supported by a relatively higher level of reserves than other oil companies. Petrobras generates good cash flow from its production, the dividend payout is reasonable, and it is trading at a low valuation to its peers.
Longer term, it's anyone's guess as to what the future holds for the oil sector. While many pundits are suggesting that we'd best get used to high oil prices, most Wall Street analysts are projecting oil to decline back to below $30 a barrel within two years.
Should this be the case, major oil companies would likely go back to their normal plodding, high-dividend yield ways. If oil stays high, though, investors could be in for a prolonged period of capital gains and higher dividend growth.
In either case, while Petrobras isn't my favorite idea for investors looking to invest in energy, it does deserve a look for more value-conscious investors who aren't afraid of coming into the industry a bit late in the cycle.
For more from the oil patch, please check out these other articles:
Fool contributor Stephen Simpson, a chartered financial analyst, owns shares of PetroChina.
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