Access to Interactive Model. Password is above disclosure.
Update on 2022-02-01, 11:24 a.m.
Starboard just sold its stake from one of its invested funds in 3R during the opening. So if I’d guess, the fund has to return the capital to its stakeholders. However, Esmeralda FIP is also owned by Starboard and has a longer holding period.
Don’t worry. Fundamentals haven’t changed. I say that with skin in the game, folks. My today’s opening order:
Hi.
This is the first report from the Brazil Small Caps Series. More than investing in $PBR, $VALE, and $EWZ, I believe there are exciting opportunities to invest in Brazil.
As I found out after spending a little time researching, if you’re a non-resident, it’s sort of easy to invest in Brazil. For more information, you can reach your BofA, Citi, GS, CS, JPM, MS, or UBS broker. Those are the institutions authorized to fill orders in Brazil.
If you want to open an account in a local institution, I would pick BTG Pactual or XP Investimentos. However, I believe both require an income above $200k or net worth above $1M.
Given the bureaucracy to open an account in Brazil, I wouldn’t tell you that in vain. There is a tremendous opportunity to invest in Small Caps locally.
After careful thought, I decided to write about a few Brazilian small caps, which returns can be tremendous (5x/10x/15x/…). Writing on Small Caps was made after a foreign investor asked me about the most significant gains in my career.
They were investments in a Small Cap that soon became a Middle and then a Large Cap. Especially in the past five years, when access to the market widened for private companies, discrepancies in valuation became more usual.
The lack of investors, qualified analysts, and liquidity created outstanding opportunities for those following these companies.
For instance, the company we’re talking about today is trading at 6x EV/EBITDA 22e, according to the market consensus. In my numbers, the company is trading @2x EV/EBITDA for 22e and 1,6x for 23e, for net cash company, generating cash. No catch. We’ll go over the numbers, and you tell me if I’m wrong.
Junior E&P in ascension
3R Petroleum (“3R”, BVMF: RRRP3) operates in the oil and gas sector, focusing on the redevelopment of mature fields in production, located onshore (onshore) and offshore (offshore), including deep and ultra-deep waters, such as the pre-salt, for example.
The company's business consists of acquiring mature Brazilian fields with a low recovery factor (little investment in maintenance) and improving production, either by increasing the reservoir's drainage network with new drilling or by changing the extraction systems, that is, the insertion/increase in the application of the volume of fluids in the recovery projects.
The company's strategy can be separated into two parts. The first is organic growth through the development of the current portfolio, and the second is through inorganic growth, through the acquisition of mature assets, with certified reserves.
Initially, 3R has approximately 80% of its business in onshore and nearshore assets, where most of the management expertise comes from. Even so, the company signed a strategic partnership with DBO Energy, which specializes in off-shore operations, in addition to bringing an experienced executive from the sector.
Participating in consolidating exploration and production in Brazil, 3R has acquired ten assets since 2019. Over the next few years, although we expect the company to focus on organic growth, we do not rule out mergers and acquisitions activities.
Within inorganic growth, we highlight targets that add (i) production; (ii) with proven reserves that can be certified; (iii) increasing production from investments with accelerated payback; (iv) with facilitated logistical investment; and (v) lower lifting costs when compared to other companies operating in deep waters.
Unique Moment for Exploration and Production in Brazil
We understand that the current moment presents a unique opportunity for smaller Exploration and Production (E&P) companies. With Petrobras' divestment program, previously set aside assets have become a golden opportunity for a new group of companies.
Since you’ve been reading my stuff for more than a month, why don’t you redeem a free trial?
From 2002 to 2017, Petrobras focused capital allocation on projects that demanded tremendous capital invested in exploratory campaigns and refining. Over the years, this has been reflected in oil production, especially those located onshore.
However, unlike many assets, an oil well depends on recurring investment to retard production decline in the following year.
Without proper maintenance, the well’s recovery rate of volumes drops year after year, making some assets with excellent cash generation potential less productive.
The image shows the daily production of onshore oil since the foundation of Petrobras. Over the past 20 years, daily onshore oil production has dropped from 230,000 barrels to just over 80,000 barrels a day today.
The scenario changed a lot from 2017 when Petrobras management and the controller decided to start an asset divestment program and focus more on the pre-salt.
An essential part of the divestment program included this base of forgotten assets but excellent quality, allowing the birth of Juniors E&P (smaller companies focused on exploration and production).
The current moment, as well as the last few years, will be decisive for these companies. Actions taken today will define the size of these companies in the future when it is challenging to grow inorganically.
Keep reading with a 7-day free trial
Subscribe to Giro's Newsletter to keep reading this post and get 7 days of free access to the full post archives.