This Could be the World’s Best Oil Stock

There may be no better time than right now to invest in  energy stocks — particularly in one of my favorites. This stock is a large and well-known oil and gas producer, and is doing markedly better than the energy sector as a whole, jumping about 18% already this year, compared with a roughly 9% gain for the sector. Furthermore, I think the stock has plenty of potential to significantly outpace the energy sector and overall market for years to come.

Why? If you follow the energy industry, then you’re probably aware of the massive offshore oil discoveries this company has made during the past four or five years. There are several, but one of the most publicized is the Tupi oil field, located in the deep waters of the Santos Basin about 160 miles off the coast of Rio de Janeiro.

Tupi is estimated to contain 5-7 billion barrels of recoverable oil, which was between 35% and 55% of Brazil’s total reserves of 14 billion barrels when the find was announced in November 2007. Moreover, the general area in and around Tupi holds and estimated 123 BILLION barrels — all of which this company is in a prime position to recover.

As the table below illustrates, this places Brazil among the world’s leading oil nations, not all that far behind Iran and Iraq, each of which has roughly 150 billion barrels of recoverable oil, and right on par with countries like Kuwait and the United Arab Emirates (UAE), which have about 100 billion barrels each.

If you haven’t guessed by now, I’m referring to Petroleo Brasiliero (NYSE: PBR), the state-owned Brazilian oil and gas firm, better known as Petrobras.

Petrobras will certainly try to wring all the profits it can out of its prized new assets in the Santos Basin. It’s already a year into a five-year expansion program in which it plans to spend $225 billion on the technology, personnel, deepwater drilling equipment and refining capacity needed to extract and market the oil. Between new and existing wells, management projects the company will be producing about 610,000 barrels of oil per day by 2015, up 144% from a current daily total of around 250,000 barrels.

Assuming oil meets price forecasts of $100-$110 a barrel for the next three to five years (and I can imagine prices easily going much higher because of rising tensions with Iran), analysts predict annual growth of 9% in sales, 11% in earnings and 20% in dividends during that time. Such growth would increase sales from $141.8 billion to $218 billion a year, earnings per share (EPS) from $3.60 to $6.07 and dividends from $0.15 to $0.37 a share.

And I wouldn’t worry at all about the above-average run-up in Petrobras’ stock. Although a situation like this might suggest a stock is racing ahead too fast and could quickly become overvalued, I don’t think that’s an issue here. The stock had an awful 2011, dropping 32%, compared with an overall gain of about 5% for its peers in the integrated oil and gas industry. The poor stock performance stemmed from earnings misses, particularly a 26% decline in profits to $3.6 billion in the third quarter of 2011 from $4.5 billion in the third quarter of 2010. As a result, at around $29 a share, the stock is still trading 30% below the one-year high and 60% below the five-year high.

Basically, I see this as yet another case of Wall Street unfairly punishing a quality stock because of short-term setbacks. But this tendency for Wall Street to overreact could greatly benefit investors with a long-term view because it has helped position the stock to be one of the best performers of 2012 and well beyond.

Risks to Consider: Although Petrobras’ oil discoveries hold great promise, the deepwater operations necessary to extract them will be difficult, and costly errors may occur. For example, an accident last November in which Chevron Corp. (NYSE: CVX) leaked an estimated 2,400 barrels of oil while operating off the coast of Brazil illustrates the potential danger, even from a relatively small incident such as this. Fines for the incident have reached $28 million so far, with more to come.

Action to Take –> Petrobras is an excellent value despite the recent spike in price, so now is a good time to buy. The stock’s price-to-earnings ratio, for instance, is only 4.8 — even though investors have historically been willing to pay as much as 14.3 times earnings for the stock. This suggests shares ought to be trading closer to $51 (14.3 x 2011 EPS of $3.60 = $51.48 per share) — 75% higher than where they are now. I think the stock is capable of delivering this sort of return in the next three to five years as the expansion of Petrobras elevates Brazil to the status of an elite oil-producing nation.

P.S. — This is just the tip of the iceberg when it comes to dividend investing opportunities in the energy sector. Last year, one of my picks distributed nearly $10 per share to its each of its shareholders. That’s almost $10,000 in income each year for every 1,000 shares you own. In this presentation, we’ll tell you more about this stock and several others like it.