“The Next Exxon” and “Next Transocean” Robert Hsu

By Travis Johnson, Stock Gumshoe, June 12, 2008

Of course, the big question is: does anyone really have a speculative fervor to find the next ExxonMobil? I suppose if you can find an oil major before it becomes a major you’re going to do great, but in recent history XOM has not been such a great deal. Oil has gone from roughly $30 a barrel to $130 a barrel in five years, during which XOM has more or less doubled. A 100% gain is nothing the shake a stick at, of course, but if they had any barrels of oil just sitting around during that time the oil itself would have gone up in value by more than 300%.

But anyway, everyone knows ExxonMobil, and since they are currently the most profitable public company in the world (in terms of sheer earnings), we all hear about them all the time — when they’re booking those record profits, or when they’re fighting off efforts by the Rockefeller scions to change their business practices, or, on occasion, when their CEO testifies that no, thank you very much, they’d prefer not to pay any extra taxes on their profits. Everyone knows them, so it’s a natural comparison for any touted oil company.

Which brings us to our point, of course — and faster than usual, you may have noted. Robert Hsu has been touting this company for a little while now, trying to drum up some subscribers to Asia Edge, which is his more expensive “greater Asia” newsletter that buys companies that are influenced by the rise of China (as opposed to his more direct China plays in the China Strategy service).

“It is the largest find in a generation and it belongs to one oil company.

“And this one unknown company suddenly has the prospect of becoming the next Exxon.

“The news, still unreported in the general press, is about to rocket our two top buys here at Asia Edge into the spotlight and hand my subscribers at least one double, maybe two.”

The argument is, essentially, that the wild rise in the price of oil is due in large part to the rise of Asia as an oil consuming region — particularly China.

“The reason gas prices are so high in the first place is the Asia juggernaut. Two out of every three oil tankers rumbling through the Straits of Ormez these days turn east, towards Shanghai, not west towards New Orleans.

“The mad scramble going on in Africa right now, the boom in Brazil, the politics in Russia and soon, the election here in the U.S., all have oil at the epicenter.

“And Asia is on the trigger.

“So this giant discovery comes to light at a very, very special moment.”

Sounds pretty good, eh? Make you want to take your oil tanker out of mothballs and get out there picking up some loads bound for Shanghai? Or maybe put up a drilling rig in your backyard to see if you’ve got a few barrels of crude under the basement? Lot of that going around these days.

Hsu tells us about this massive new oil discovery, which he says has fleets of oil rigs lined up “155 miles east of Rio” — that being Rio de Janeiro, of course, with the offshore oil discoveries being discovered in Brazilian waters.

There are actually two stocks teased here — the one he describes as a drilling company that has a good position in Brazil and that “Transocean would love to buy” — he doesn’t actually call it the “next Transocean,” that was my own little magical touch … and the oil company that he calls the “next Exxon.”

Let’s look at the driller first — here are the clues:

There are a very small number of ships and rigs capable of drilling in the difficult conditions offshore Brazil — not because it’s particularly rough like the North Sea, but because the oil is so deep, and is sealed under a hard crust of salt. So the owners of those rigs are demanding a pretty penny for their services … which should lift the hulls of all of these companies, as you might notice it has. But Hsu has one particular one in mind:

“It’s booking into 2011 at $450,000. Word is, rates could top $600,000.” (They already have for some rig owners, so this text must be a little old)

“Earnings are growing at a breakneck 128%, debt is zero and the big guns like Transocean would love to snap it up.”

“Asia Edge subscribers saw this stock shoot up 34% in 4 weeks recently, then consolidate as the price of oil dropped. Beautiful. Buy it and don’t look at it for one, maybe two years.”

Think that’s enough, clues-wise? Well, it all depends. There are only a half-dozen companies in the world that could legitimately claim to be “top drillers” offshore, so our universe is small. And a couple of those are not particularly active in Brazil, so it shrinks a bit further …

And the Thinkolator can with at least some degree of certainty announce that this is …

Pride International (PDE)

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The 34% rise in four weeks “recently” was a couple months back, when it was first announced that SeaDrill had taken a near-10% stake in Pride and the takeover rumors started circulating (again — I helped goose those rumors a couple years ago, for the same two companies, though I was clearly very early).

Pride arguably hasn’t gotten the same level of attention as have Transocean, Noble, or Diamond Offshore — partly because PDE also has a small collection of land rigs (mostly in Chad), and runs a large number of old, shallow-water rigs, mostly in the Gulf of Mexico (including a lot of jackups leased to Pemex). But they do have a pretty big deepwater fleet, albeit not as many of the really brand-new high spec rigs as some of their competitors — and many of their most capable rigs and drillships are leased to Petrobras, at rates up to a bit over $500,000 a day (most of them are a bit older and have shallower capability, so they’re more in the $200-350,000 range). Pretty nice stuff. So the valuation might look fairly attractive if you decide to research it further.

Frankly, I think anyone that has a good fleet of deepwater rigs is likely to make a mint for the next eight years (for these most capable rigs, ones that can drill in 5,000-10,000 feet of water, anything more than four or five rigs might be considered a “good fleet” — there just aren’t that many of them yet) — that’s when contracts are running through now for these better rigs, they’re being signed through 2015-2016 and sometimes even longer. And a lot of them are going to Brazil, where the Tupi find and other offshore exploration are putting a severe strain on a worldwide fleet of deepwater drilling rigs that was under-invested during the days of $10-30 oil. There’s even a contract in place for another firm to get more than $400,000 a day for a drillship that, by the time the contract ends, will be almost 40 years old. So the demand is there.

That underinvestment is certainly changing, though the new rigs on order are still coming fairly slowly and the operators now have the leverage to demand long contracts and high rates for rigs that won’t be delivered until 2011, so it looks likely to remain a sellers market for quite some time. Those who have followed this space for a while know that I personally own Seadrill, which still holds a piece of Pride International though seems unilkely to buy the whole outfit (you never know, but Seadrill is making noise about strategic relationships and other transactions, and is probably most interested in acquiring PDE’s order book or some of their deepwater rigs … which are, of course, the valuable assets that PDE probably least wants to sell). Seadrill is also the latest beneficiary of Brazil’s largesse, inking deals for several deepwater newbuilds that start over the next few years, at record day rates of around $600,000.

So I have nothing particularly bad to say about Pride, except that they’re not necessarily as levered to the newest deepwater rigs as I’d like to be. They’ve got good assets, and I agree with Hsu that one of the other big players (NE, RIG, Seadrill, DO, etc.) would probably be happy to buy them at the right price, but I don’t expect we’ll see much more of this kind of large-scale consolidation in the industry with rates as high as they are … no one’s hurting now, so no one needs to sell, and the US companies, at least, tend to be fairly conservative when rates get high.

And from the hints given, I can’t be absolutely certain about this one — of the major drillers, PDE is the only one that had earnings growth of near 128% in any recent quarter, but by my calculation it was actually 132%. And the others did have moves similar to PDE’s 34% spike in April/May, but PDE is a better match there, too. PDE also does have a little bit of debt, though it’s negligible, so there’s room for me to be wrong on this … but frankly, I expect that there’s plenty of room to be wrong in buying any deepwater driller, they should all have remarkable profits in the coming years. If you’d like to look into these companies, you probably can’t go wrong with Pride (PDE), Noble (NE), Transocean (RIG), Diamond (DO), Atwood (ATW) or Seadrill (SDRLF), and you might also look at Ensco (ESV), which is late to the deepwater game but with several on order (like Pride, they’ve got a lot of shallow water jackups). If you’ve got a favorite, feel free to share.

And as I said, I own shares of Seadrill, which in turn owns shares of Pride and is also competing with them for Brazilian and other contracts, so take my opinion with a grain of salt.

Moving on … what’s the “next Exxon”?

You’ve probably already guessed this one, since Brazil is one of many countries that has a publicly traded but state-controlled oil company that dominates the market. But stick with me, just for fun …

“But above all of this, a relatively unknown, unfollowed Brazilian oil company just got what Getty got at Spindletop: access, in a single piercing thrust, to 150 years of more wealth than the demigod Avarice ever dreamed of.”

“Relatively unknown” is a bit of a stretch, I’d say, since this has grown to be one of the larger companies in the world, but this is, of course …

Petrobras (PBR or PBRA for the NYSE ADRs)

Petrobras is the Brazilian oil company, and they control much of the offshore finds — in fact, it has been their enthusiasm to drill actively and get test wells underway before their leases run out that has much of the offshore rig market jumping of late. Though they’re largely owned by the government, they still have to bid for leases like everyone else (they have an advantage over most foreign bidders, but certainly folks like British Gas and Exxon and Repsol and most of the other big guys are actively bidding for leases, and getting some). And there are rules for the leases — if you don’t explore, or don’t book your reserves, or whatever the various qualifications are, you lose the lease. Once this big discovery was made and the stakes were raised — which has really just been within the past year — Petrobras got much more motivated to expand it’s exploration offshore to make sure they don’t lose any good prospective fields.

So that’s why Petrobras is throwing money at Pride, Seadrill, Noble and the rest of them.

What does it mean for PBR? Well, if you’re convinced that they’re going to be able to produce all the potential oil in this massive field, this is a transformational change for Brazil and for Petrobras. It wasn’t that long ago that Brazil was worried enough about their oil future that they build probably the world’s largest functional ethanol market (in some contrast to the US dysfunctional one). But it will probably be at least five years, if the experts I hear opining are accurate, before they have gushers of oil ready for the refinery from these monster fields, and longer before they reach maximum production. I’d bet that oil prices will still be high in five years, but I have no idea how high … and that’s really just a guess, given the increasing demand around the world, including in oil exporting countries, and the lack of other massive discoveries on par with Tupi in recent years.

I owned Petrobras shares several years ago — it was absurdly cheap then, as opposed to just plain old cheap now, and back then Petrobras was probably the only company in Brazil that most people would have considered a trustworthy investment. That market has expanded dramatically, and Brazil, even with a recent inflation spike, has been upgraded in the eyes of the institutional investing world, and many more Brazilian companies are probably worthy of investment (I happen to own one, Sadia, and have considered many others).

So it’s not exactly the wild frontier anymore. And perhaps I’m a little bitter, so you might consider that as you ponder my comments, and my reluctance to climb back on this freight train of a stock whose chart has been moving in almost a straight line up for four years (I sold PBRA for a bit less than a 100% gain in late 2004 … at a split adjusted $10 a share or so. It’s now at $55).

After all those years of stock gains, the re-emergence of Brazil, high oil prices, and the Tupi discovery, Petrobras is no longer priced like it’s operating in a wild frontier country — the shares trade at a trailing PE much higher than many of their oil major peers, like StatoilHydro or ExxonMobil or ChevronTexaco or ConocoPhilips, but it is expecting some much more significant growth over the long term, thanks largely to those offshore finds. Man, that’s a lot of mergers — I wonder if we’ll be talking about PetrobrasRepsol some time in the near future? Probably not, but the oil company with a single name must feel quite lonely these days.

If you are interested in Petrobras — and I wouldn’t blame you, though I’ve not convinced myself to buy back in — I’d urge you to look at the A shares. PBRA is the same company, a different share class, and has a better dividend policy and a lower share price and PE ratio — volume is lower in the US for the A shares, but certainly not low enough to impact individuals, and you probably give up some of your voting rights … but Petrobras management isn’t going to listen to you, anyway.

I don’t know whether PBR is likely to have weaker dividends in the next few years as they invest heavily offshore (dividends are a portion of earnings, they make no effort to have a steady dividend), but certainly over time PBR will probably have a decent yield and solid growth … the only question is whether you’re willing to pay up for the growth right now, when Brazil is the world’s darling, oil is at $130+, and the excitement of the Tupi field is on everyone’s lips. It’s also going to cost a real bundle to get that oil out of the ground/ocean, as we’ve seen from the sky-high rig rates … though it’s a huge field, it’s quite different from the Spindletop “Beaumont Miracle” that had oil just gushing out of the ground.

Maybe Petrobras is worth it at this price, maybe not, but this is a growth stock, not an undervalued gem … and regardless of what Hsu says, at $300 billion in market cap there are precious few investors left who haven’t heard of the company or its rapidly rising stock — so take your time, and keep your eyes open.

full disclosure: as noted above, I do own shares of both Seadrill and Sadia. I am not invested in any other company mentioned.



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A. Nony Mouse
A. Nony Mouse
June 12, 2008 10:58 pm

It’s Atwood (atw)…there’s a glitch in the thinkolator

A. Nony Mouse
A. Nony Mouse
June 12, 2008 11:32 pm

I kid you not Atwood Oceanics IS THE STOCK TOUTED. My question for you is regarding PBR A, when there is a 2 for 1 stock split, do these shares spit also?

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A. Nony Mouse
A. Nony Mouse
June 12, 2008 11:38 pm

As for Sadia, with an outbreak of Bird Flu in Hong Kong and a kill the chickens ordered by the govt there, Sadia may be in the same position that they were in with pork during the Chinese Swine Flu outbreak in the recent past, ie in the cat-bird’s (flu) seat

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June 13, 2008 4:25 am