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The investor’s guide to hidden profits off the coast of Brazil

There's an oil boom looming in the sea basin off Brazil, says this analyst, and one undervalued company should get to the profits first.

Spanning the globe to bring you the widest possible range of investments, we touch down on the coast of Brazil. Not on the beaches at Copacabana or Recife, but out in the ocean.

We’re here for oil. Our guide is Mr. Randy McDuff, who takes us down to Rio (sort of) in the pages of Investor’s Digest of Canada.

Mr. McDuff is a conspicuously successful investor. Retiring early from the brokerage business in Winnipeg, he runs several successful portfolios on Marketocracy.com. In fact, he has two of the top 10 portfolios among the 50,000 on the site.

He tends to unearth investments that would otherwise escape the notice of investors. In this case, it’s not an oil company, but a supply firm that stands to draw the earliest profits from Brazil’s forthcoming oil boom.

Elephant-sized fields

Campos, Santos and Espirito Santo may sound vaguely like Columbus’s three ships, but they are bound to produce a lot more wealth than ever fit in the holds of the Nina, Pinta and Santa Maria.

They are Brazil’s offshore oil basins. If speculation is correct, their production may ultimately rival that of the rich North Sea offshore fields.

As Mr. McDuff puts it: “While one elephant-sized field is generally all that is required to turn a company into an oil ‘major’,” the concessions owned by the Brazilian oil company Petroleo Brasileiro S.A. or Petrobas (NYSE-PBR), “may potentially be home to an entire herd of elephants.”

Production from the new deep-water finds isn’t likely to begin before 2011, adds the analyst. “However, the companies that provide infrastructure to offshore rigs are already profiting from offshore contracts.” The most attractive of these firms, in Mr. McDuff’s opinion, is Wilson, Sons (Bovespa-WSON11).

Mr. McDuff assures his readers that the shares of Wilson, Sons, which trade on the Sao Paulo Exchange, are easily obtainable. They are quoted in Brazilian reals and converted to Canadian or U.S. dollars at purchase. “I was able to place an order with my full-service broker as easily as with any TSX listed security.” Now here’s why they’re worth obtaining.

By land and by sea

A partially state-owned firm, Petrobas has a mandate to distribute oil wealth throughout the Brazilian economy. Wilson, Sons may reap the greatest harvest of this manna from the oil fields.

The company is strong by land and by sea. It has two container terminals and an oil terminal. It builds and owns drilling-supply vessels and it owns the largest and most modern towing fleet in South America.

Wilson, Sons’ fast-growing logistics division manages 1.5 million square feet of warehouses and handles shipping and storage for a number of multinational and domestic companies.

The company was not born yesterday, or the day before. It dates from 1837, but its greatest growth has come very recently. Its IPO on the Sao Paulo exchange dates from just last year, when it raised $117.8 million (the author converts all amounts from reals into U.S. dollars).

Trading at a discount

Wilson, Sons is cheap at the price, says the analyst. Its American Depositary Receipts were listed at US$11.74 — just 10.6 times the trailing EV/EBITDA ratio (enterprise value divided by earnings before interest, taxes, depreciation and amortization), a key measurement for Mr. McDuff.

“Perhaps due to its limited history as a public company,” he says, “this rapidly growing small cap is priced at what I consider to be value multiples. The discount certainly can’t be attributed to a weak balance sheet.”

With total liabilities of just $55.6 million, Wilson, Sons has 71.2 million shares outstanding for a market cap of $937 million. From 2005 to 2007, revenue grew by 18.9 per annually while EBITDA grew by 28.8 per cent. Over the past 36 months, net profits rose by an imposing 43.8 per cent.

The sum raised by the IPO has been put to work on a major expansion of all operations. Over $220 million has been earmarked for spending. By the end of 2008, port capacity will have increased by 55 per cent (the terminals were running above capacity and had to turn business away).

At sea, 12 more towing vessels will be added this year, and the wholly owned fleet of drilling supply vessels will grow by more than 130 per cent by 2010. A Chilean firm just signed a $100 million, four-year contract for Wilson, Sons vessels, and Petrobas has put out a tender for 24 more.

Doubling earnings in three years

All this expansion should translate into much more revenue. Mr. McDuff estimates that by 2011, revenue could grow by more than $200 million, to $610 million, and EBITDA could multiply from $49 million to $180 milllion. “If my forecast is correct,” he says, “three-year EBITDA growth of 96 per cent is possible, on revenue gains of 51 per cent.”

Yet all this potential hasn’t found its way into the share price. Wilson, Sons trades at lower valuations than slower-growing peers like Trico Marine (NASDQ-TRMA), Hornbeck Offshore (NYSE-HOS) and Gulfmark Offshore (NYSE-GLF). “Arguably, a faster-growing company with a stronger balance sheet than peers deserves a premium valuation.”

Mr. McDuff prefers owning “companies capable of doubling earnings in three years, without leveraging up their balance sheets.” Wilson, Sons fills the bill admirably — and it intends to pay out 25 per cent of net annual profits in dividends.

Home-field advantage

“Wealthy people often attribute success to simply being in the right place at the right time. If this is the case for individuals, can’t this also be true for entire companies?” asks Mr. McDuff.

It certainly should be true for Wilson, Sons, which is due to embark on an extended run of good fortune. The results of its capital spending program should be apparent to all in 2009, says the analyst, keeping right in step with the developing Brazilian economy.

Above all, Wilson, Sons will have the “home-field advantage” over foreign competitors when it comes to doing business with Petrobas.

Mr. McDuff draws the following conclusion for his Investor’s Digest of Canada readers: “Intrepid global investors will find this small-cap stock to be right up their alley.”

His three-year target price is $26.80 per share, just about 102 per cent above the current price of 20.45 reals, or US$12.65.

Investing overseas is a lot like traveling there. There’s nothing better than finding someone who will take you off the beaten path to a great attraction the rest of the world hasn’t discovered yet.