A brand new Oil Company ADR: Ecopetrol SA (nyse: EC)
Ecopetrol ADR (EC-NYSE $23.65) 3.1X forecast 2009 EV/EBITDA
All amounts are quoted in US. The conversion rate from Columbian Pesos to US dollars on September 29th, 2008 was $.0004784. 1 US dollar =2090.5 COL pesos
Shares outstanding: 1.55 billion
Total liabilities short term cash on 12/30/2007: .71 billion.
Enterprise Value: 09/29/2008: $37.35 billion.
EBITDA generated in 2007: 9.6 billion.
Trailing 2007 EV/EBITDA ratio: 3.9X
Forecast 2008 EBITDA: $13 billion
Est. 2008 EV/EBITDA ratio: 2.8X
Forecast 2009 EBITDA: $11 billion.
Est. 2009 EV/EBITDA ratio: 3.X
American Depository Receipts of Ecopetrol (EC) have recently been listed on the NYSE. Each ADR represents 20 underlying shares of Ecopetrol common shares, which trade on the Columbian stock exchange. The shares were issued to Columbian citizens pre-market at $13.40 US. Since listing, the underlying EcoPetrol shares have traded in a 52 week range of $20.20-$33.00 US. The ADR of Ecopetrol started trading in North America on September 18th, 2008
Previously a government enterprise, Ecopetrol shares were floated to the public on November 28th, 2007 on the Columbian stock exchange. Each Columbian was limited to about $700 of initial investment at the time. The Columbian government still holds more than 89.9% of the total capitalization.
Ecopetrol was listed on the NYSE to provide a more liquid market than the Columbian stock exchange could offer. The company intends to create an international profile in line with companies such as Petrobras. Ecopetrol reports 1.45 billion barrels of 1P oil equivalent reserves (1.8 billion barrels including 2P). Other assets include 2 refineries with the capability of processing 270,000 bpd, 8400 km of pipelines and petrochemical facilities. Oil and natural gas production averaged 399,000 boepd in 2007.
Ecopetrol is virtually debt free, reporting just $708 million of net liabilities on 12/31/07. Among oil companies its size, ECO has arguably the strongest balance sheet in its class.
Management intends to boost oil production from 399,000 boepd in 2007, to 1 million boepd by 2015.
All oil companies tend to talk up strong production growth potential, which is seldom realized. For a major to forecast an 18% plus annual production growth rate in the next 8 years seems almost absurd.
Ecopetrol however, has a unique operating advantage over many oil companies in South America. The firm can back into almost any new discovery made in Columbia, to a potential 30% holding. This trigger can occur when EC pays all costs incurred to the point where a discovery is declared commercial. Columbia boasts a low royalty regime (5%-25% of production). Corporate taxes are currently 33%, and have declined sharply in Columbia for the past 5years. This attractive fiscal regime has sparked renewed interest in this oil prone country. Too, Columbia has large heavy oil deposits which are likely to be exploited in the years ahead. The geography is quite similar to Venezuela, which has substantial heavy oil deposits.
The attractive fiscal regime, heavy oil potential and development initiatives underway in key oil basins, give me confidence that EC is likely to grow production materially in the years to come. A 150% increase does seem to be a stretch, but review of the field potential does suggest a potential doubling of production over the forecast period.
Thus far, as a public company, Ecopetrol has made good on their goals. In the first half of 2008, output rose to 438,000 boepd. This compares to the 399,000 boepd produced in 2007, a gain of 9.8%.
http://www.ecopetrol.com.co/english/documentos/41492_Ecopetrol_en_cifras_Junio_08-ingles.pdf
Management intends to boost recovery factors from existing fields using improved technologies. Too, Ecopetrol intends to take a more active interest in exploration and development, in and around, key underexploited fields. It does not seem unreasonable to suggest that 2P reserves might grow to almost 3 billion barrels by the end of 2015.
Refinery capacity and petrochemical output is forecast to grow dramatically in the next 7 years.
Management intends to double refined output by 2015. Petrochemical production growth of almost 475% is planned in this period.
Provided that oil remains in the $90-$100 bpd range for the next 7 years, internally generated cash flow should pay for this expansion.
A better known peer, Petrobras, intend to increase output by about 1/3 in the next 7 years, but might need about $250 billion of external capital to meet this goal. Ecopetrol intends to spend about $60 billion in the next 7 years, with a view towards more than doubling in size. This will be less than forecast EBITDA, which suggests minimal need for external capital funding.
The shares seem very inexpensive on an EBITDA basis.
Ecopetrol generated $8.99 billion of EBITDA in the first half of 2008, up from $5.1 billion in the same period of 2007. Oil prices have moderated since Q2, but are still higher than in 2007. Should oil prices remain in the $90-$100 per barrel range for the balance of 2008, EC may generate as much as $13 billion of EBITDA in 2008.
The balance sheet appears to be improving. Capital expenditures are forecast to range from $4.1-$4.6 billion for 2008. As this is less than half of forecast EBITDA, EC may report a positive net cash balance at the end of 2008.
It clearly appears that the windfall profits from high commodity pricing are over for the industry.
Most global oil companies grew EBITDA rapidly in the last 24 months based on extraordinary pricing of oil. Production growth in large caps was largely stagnant. Now that oil pricing has moderated, the majority of large cap exploration and production companies will begin to post declining quarter over quarter comparisons. In short, the market will now start to become highly selective.
Companies that look capable of outperforming their peers will need to be low cost producers, in lightly taxed jurisdictions, with clearly defined growth prospects. Ecopetrol seems to fit my criteria nicely. Columbia, while virtually unknown to investors, boasts a declining corporate tax rate (33% for 2008) and royalty rates of 5%-25%. I believe that the Columbian economy has excellent macro potential overall.
While EC will not match 2008 EBITDA forecasts in 2009, the shares seem awfully inexpensive on all valuations. Oil prices are such that conventional producers will make strong profits. Shale oil and shale gas producers, with their extremely high capital costs and low productivity, will not be so lucky.
Spotting a potential multi-bagger early always invites the wrath of sceptics.
The company looks like an early version of Petrobras (PBR), which I purchased way back in the 1990's. Then, I took plenty of flack from the professional investment community, for purchasing shares of a third world oil company operating in a leftist country. Considering my country of origin, this seems deeply ironic.
Now, PBR is an integral part of most international oil portfolios and Brazil has a larger economy than Canada. Many of these experts who refused to acknowledge the thesis early on, now feel quite comfortable calling PBR a buy, at prices more than 15X above my initial purchase price.
Ecopetrol is NOT a suitable investment on a stand alone basis.
The shares are completely unknown to the public, and are not liquid at present. 89.9% of the stock is tied up in government hands. At best, a further 9.9% of the shares might come to market someday. Further, the stock started trading at a precipitous period in the markets. Improved institutional attention will NOT be forthcoming in the near term. As the firm should require minimal capital from external sources, brokerage firms will not pay any attention to the ADR.
Ecopetrol should only be considered as an extremely long term investment and should be no more than a modest portion of a well diversified global account. That said, I predict Ecopetrol will one day be a widely held investment in oil accounts, much like Petrobras. I will be happy for broadly based markets to inevitably arrive at my conclusions, and will be soon adding shares for the Marketocracy large cap account.
My 7 year forecast hold period might be made more comfortable with a decent dividend. Based upon 2007 results, EC paid out a basic dividend of $.80 US per share, a 3.3% dividend rate. Provisions exist for a bonus payout annually, which added a further $.60 US per share, or 2.5%, to the 2007 amount.
Plenty of oil companies pay dividends far above this rate. However, the cushion of safety at most is inadequate, when oil is $90 per barrel and gas is $7 per mcf. With a highly conservative balance sheet, Ecopetrol's basic rate could grow steadily over time.
The corporate website, in English, may be found by linking here:
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