Tag: PXT

Petrobas, Parex Resources – Complexities of foreign jurisdiction hydrocarbon investing

On paper, the valuations of various international oil/gas producers look quite cheap.

One example is the state-owned enterprise of Petrobas (NYSE: PBR).

For the past 12 months, they generated about USD$37 billion in cash. Their current market cap is about USD$69 billion, and net debt is US$48 billion (total EV US$117 billion), so an EV/FCF of about 3.2x. Really cheap-looking!

Also, there is no denying that shareholders have received some capital back in the form of dividends:

For 2022 alone, this has totaled USD$4.13/share in dividends.

When dividends are this high in relation to the existing share price (US$10.54/share), it is instructive to look at the stock price unadjusted for dividends:

So let’s say you lucked out during the Covid low (March 2020) and bought your shares of PBR at US$5/share.

Today you would be sitting on a cumulative dividend of US$6.27/share.

Needless to say, this is a very healthy cash return on investment.

The question is – is this cash stream going to continue in the future?

Political considerations would have one believe otherwise. Jurisdictions all over the world, ranging from the United Kingdom, the EU, Colombia and the alike have either implemented or are calling for “windfall profit taxes” to be levied on hydrocarbon companies.

The history of Brazil and Petrobras I will not explore in this post, but needless to say, it is quite the story about how very profitable state-owned resource enterprises are, not shockingly, not optimized for shareholder returns.

The history of Mexico and Pemex is another one.

Venezuela and PDVSA.

Saudi Arabia and Aramco.

I can go on and on.

Finance and politics go hand in hand. When dealing with politically sensitive sectors such as hydrocarbons, political considerations must be in the investing toolbox.

In the case of Petrobras, “too difficult” is all I can come up with. I have no idea about the legislative framework and the relationships between the government and its state-owned agencies, nor do I have a way of assessing whether the new presidency will be able to substantively enact hostile actions to minority (let alone foreign) shareholders. In general, not even knowing the language of the land is enough of a disadvantage, let alone all of these other prevailing considerations.

Just like when investing in a company with a controlling stake, you always have to have a precise assumption of the intentions of the controlling stakeholder before diving in.

We fast forward to Parex Resources (TSX: PXT), which, just like Petrobras, on paper looks extremely cheap.

Its market cap is US$1.5 billion, and it has net cash of US$350 million, leaving it with an EV of about US$1.17 billion.

It generated free cash flow of US$275 million for the first 3 quarters of this year. Annualized, that is about US$370 million (not an appropriate extrapolation since Brent is down in Q4 from Q1-Q3 but we are doing a paper napkin valuation).

That is an EV/FCF ratio of about 3.2x. Just like Petrobras.

Looks cheap on paper, but going forward things are going to get much more expensive for the company. Colombia’s newly elected president has successfully put forward and passed a piece of legislation that is financially punitive. In addition to the general corporate tax rate increasing, there will be a 15% surcharge levied if Brent is above a certain threshold, and also royalties on oil and gas are no longer tax deductible.

This will do wonders for capital investment, let alone talks about banning further drilling.

Also not helping is the domestic situation allowing for blockades and the like against existing producing facilities (run this through Google Translator).

Parex will likely be best valued as a run-off facility. The question becomes whether it is worth it for them to propose a significant amount of capital expenditures to keep their facilities pumping at current levels or not, even if this can be achieved in a regulatory environment that makes Justin Trudeau look like oil and gas’ best friend.

I don’t know.

Parex has traditionally given a huge amount of shareholder returns via the share buyback route – they have maxed out their 10% NCIB in the past few years. Their new NCIB will renew around Christmas time, and that will likely give a bid to their stock. Trading-wise you might even be able to skim 10-20% riding the NCIB capital infusion. However, just because you take out 10% of your float every year for a few years doesn’t mean that your stock price will respond if your home government is taxing the majority of your future profits away. As most people know, when the government enacts a tax, it is a very rare day when they will take back the tax. Inevitably there will be a day where the commodity price environment reverses and we will never see a reverse “windfall recovery grant” given to such companies.

So despite it looking incredibly cheap on paper, I’m staying away. We’ve seen many cases in the past where the golden goose gets strangled. This might be the case and hence why these companies trade at 3.2x EV/FCF ratios.

Canadian Energy Update

Here is a quick post on the state of Canadian energy production companies – especially as the federal government continues to destroy the industry. As of September 30, 2020 there are 12 companies listed on the TSX that are over a billion dollars in market capitalization. There are 24 between $100 million and $1 billion, and some of these names are in very bad shape indeed. Also out of these 36 companies, some are TSX listed but have the majority of their operations outside of Canada.

For this post, I will focus on those above $1 billion. Companies that are under this threshold are still invest-able but one has to pay careful attention to whether they will survive or not in the hostile regulatory environment.

If your central thesis is that fossil fuels are going to decline and die in a relatively short time-frame (e.g. 20 years) then you probably won’t want to invest in any of these. Demand destruction will impair pricing and the ability to produce supply will not accrue excess gains to any names.

However, this is not going to be the case from a simple perspective of energy physics (laws of thermodynamics if anybody is interested in studying). Renewable sources do not scale to the magnitudes necessary. It also costs massive amount of up-front investment to implement renewable energy sources. It is relatively easy to ramp up energy usage from 0% to 5%, but above this, it becomes very obvious what the deficiencies are of renewable power sources (California discovered this in the summer). Putting a long story short, the more renewable (intermittent) sources you have on a grid, the better will be for on-demand generation sources – this means either you go with natural gas (fossil fuel!) or hydroelectric (we’re mostly tapped out in North America). Batteries make sense in smaller scale operations but not in state-province level grids. Or you can rely on imports, which just like liquidity during a stock market crash, is generally very expensive or not even there when you need it the most.

With respect to transport fuels, we will classify this as passenger, freight and aviation. For passenger vehicles, we all see Teslas and the like on the road, but the infrastructure required to refine and produce the battery materials to replace a substantial portion of the automobile fleet is still a long ways away. For freight, battery-powered transport automobiles are an illusion due to the requirements of existing freight haulers (you need to be able to transport 80,000 pounds of goods at a long distance and also cannot afford to spend 12 hours at a charging station to refuel).

My opinion will change if nuclear becomes a viable option again for power generation (from a political and cost perspective, not a technical perspective).

Some pithy notes (these are the C$1B+ market cap companies):
SU, CNQ – Clearly will survive and represent playing a very long game. Personally like these much more than the big majors (e.g. XOM, CHV, COP, BP, etc.).
IMO – Majority foreign (US) held (XOM), wonder if they will make an exit
CVE – The best pure-play SAGD oil sands player (maybe to be contaminated by HSE acquisition)
TOU – Spun off another sub, largest of the Canadian NG players, FCF positive
HSE – Soon to be bought by CVE – will be interesting to see how CVE makes more efficient
OVV – Mostly American now, with big major style culture and cost structure (i.e. $$$)
ARX – Second NG/NGL play, FCF positive
PXT – Substantively all Colombia operations, that said their financial profile is quite good relative to price
PSK – Royalty Corp (royalties are not my thing – just buy the futures, although pay attention to price, if they get cheap enough, royalties are typically a better buy)
CNU – Chinese held, illiquid security
VII – Liquids-heavy gasser, FCF positive (barely), a bit debt-heavy