I Was Wrong About Petrobras, But I'm Still Not Bullish

seekingalpha2023-11-11

Facing political and financial risks, Petrobras confronted concerns resembling those leading to near-bankruptcy in 2016.Changes in leadership, discontinuation of the international price parity policy,...

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The company seemed to be following the same steps that nearly led it to bankruptcy in 2016 when it held the title of the company with the highest net debt in the world and was involved in a massive corruption scandal known as Operation Car Wash, which unveiled widespread corruption and bribery within the company. The first yellow flag was repealing the law on state-owned companies, which allowed Petrobras to appoint a politician as its CEO. In this case, Jean Paul Prates, a former senator from the same party as the current President, Lula, assumed the role. The second issue was discontinuing the international price parity (IPP) policy. This policy allowed Petrobras to control its fuel prices through subsidies for social policies but negatively impacted the company's profits. With Brent crude oil prices climbing since July, Petrobras lagged behind nearly 30% on fuels under the new pricing policy. This situation has forced the company to raise fuel prices in the country. The third concern was a change in the dividend distribution policy, reducing the percentage of free cash flow distributed to shareholders from the previous 60% to 45%. Fourthly, Petrobras announced a potential investment in offshore wind energy. In my analysis, Petrobras should focus on its core activities, such as deepwater oil production, instead of venturing into new projects. Over the last 20 years, Petrobras has undertaken several destructive projects, such as Pasadena and Abreu e Lima, resulting in significant losses. However, despite all these yellow flags, my bearish stance, though not a short position, has been proven wrong throughout this year. Petrobras' shares have accumulated a rise of 60%, and the company continues to provide attractive dividends to its shareholders, generating a profit and reporting solid results (albeit less robust than in the past two years), as seen in the most recent third-quarter report. Data by YCharts While I still maintain my belief that the company's current management appears biased and that its future is tied more to subside the Brazilian government's social policies than necessarily generating profit and distributing dividends (which is somewhat paradoxical, as the government, being the largest shareholder, would be the primary beneficiary), I am attempting to adopt a more moderate stance. This shift is also related to John D. Rockefeller's famous quote: \"The best business in the world is a well-run oil company. The second best business in the world is a badly run oil company.\" Petrobras' Performance: Better Than Expected in Challenging Times Petrobras has emerged as one of the top-performing stocks on the Ibovespa (Brazilian stock market) in 2023, defying earlier pessimistic expectations. This positive performance comes in the face of a new Brazilian government led by Lula, known for his anti-market stance and the history of the Workers' Party's involvement with Petrobras, marked by corruption scandals and mismanagement during Dilma Rousseff's presidency from 2011 to 2016. Historically, Petrobras has faced long-term value erosion due to past left-wing governments. However, from 2016 to 2022, the company underwent significant restructuring under center-right administrations like Michel Temer and Jair Bolsonaro. This transformation resulted in reduced leverage, robust cash generation, record profits, and increased dividend payouts. Data by YCharts Despite the shift in political leadership in 2023, with President Lula retaking the seat, Petrobras has continued to create value for its shareholders. The market's reaction can be attributed to expectations. When initial expectations are highly negative, even if a situation deteriorates but remains better than expected, it can lead to positive market sentiment. In Petrobras' case, although its fundamentals worsened this year, the extent of the deterioration was less severe than anticipated, thus contributing to its favorable performance. To comprehend Petrobras' resilience and performance, it's essential to understand the company's operations. Petrobras produces approximately 2.8 million barrels of oil daily, while Brazil's total production is around 4 million barrels per day. Since Petrobras doesn't consume all of its production, Brazil exports roughly 1.5 million barrels of oil daily. The company specializes in deep-water exploration and mature fields, generating revenue from crude oil sales and refining. However, the challenge lies in passing international oil prices to the domestic market. Fuel pricing is a complex issue influenced by various factors, including the oil industry's structure, government fiscal policies, energy objectives, and economic conditions. Previous attempts by the government to subsidize fuel negatively impacted Petrobras' finances, given the company's substantial debt in the not-so-distant past. This year has seen changes in Petrobras' pricing policy and a reduction in the percentage of dividend distribution as a response to these challenges. Market expectations were initially negative regarding Petrobras' new pricing policy. However, in 2023, the company has adhered to market expectations, gradually adjusting fuel prices in line with international oil prices. Furthermore, fortunate circumstances, such as declining oil prices in the first half of the year, followed by an exchange rate favorable to Petrobras, contributed to the company's stock performance. The adjustment in Petrobras' dividend policy reflects its financial planning, with substantial investments planned for the coming years. The relationship between Petrobras and the Brazilian government, which holds a significant stake in the company, is intricate. Political influences affect decisions related to pricing policies, investments, and dividend distributions. Nevertheless, Petrobras is generating substantial cash flow, making a contrarian bet on the company challenging but potentially rewarding. Petrobras' Q3 Results Petrobras recently released its third-quarter results, which were impacted by two significant factors compared to the previous year: The drop in Brent oil prices and the decline in the average exchange rate. Brent oil prices decreased from $100/bbl (3Q22) to $86.8/bbl (3Q23), marking a 14% decline. Meanwhile, the average exchange rate shifted from R$5.25 (3Q22) to R$4.88 (3Q23), representing a 7% decrease. Data by YCharts As a consequence of these developments, Petrobras' revenues witnessed a year-over-year decline of 26.6%, amounting to R$124.8 billion in sales revenues for 3Q23 (compared to R$170 billion in 3Q22). With diminished operating leverage, the net income dropped by 42.2% year-on-year, reaching R$26.6 billion in 3Q23. Petrobras' IR Nevertheless, the company's cash generation remains robust, with an operating cash flow of R$56.5 billion in the quarter and a free cash flow of R$40.9 billion. Given this scenario, Petrobras is poised to sustain a free cash flow from R$150 to R$160 billion annually. Petrobras will likely maintain a double-digit dividend yield if the current dividend policy is upheld, which involves distributing 45% of free cash flow. However, my primary concern is potential investments in unprofitable assets. Such ventures could reduce free cash flow and exert immediate pressure on dividend distribution, potentially undermining the thesis of investing in Petrobras for dividends. Under these circumstances and considering consensus estimates projecting a 26% annual EPS decrease for this year, Petrobras is expected to report an annual net profit of $26.35 billion. Based on the current payout structure, this would correspond to a yearly dividend of $1.82 per share (bearing in mind the quarterly payout) and a dividend yield of 12%. Assuming an ROI of 12%, this calculation suggests an implied share price of $15.16 per share, which closely aligns with the present share price. Seeking Alpha, Company's data, table compiled by the author The Bottom Line I was mistaken in adopting a bearish stance on Petrobras throughout this year, and the stock's performance reflects my error. However, even though my long-term outlook remains pessimistic due to concerns about continued state intervention in the company for the next three years at least, the company's performance remains solid, although less compelling than in the last two years. The Q3 results state this case, and Petrobras is expected to continue distributing dividends with a double-digit yield.  Therefore, I have revised my bearish position to neutral. I understand that the market's perception that this year's events have been less adverse than expected should continue to influence the stock's price in the short to medium term, as the stock may be reasonably priced based on its dividend distribution.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2382573796"}