May 21, 2013

OGX Petroleo earnings may be running out of gas

by Sridharan Raman.

Brazil’s OGX Petroleo needs a gusher – in the ground and on its balance sheet. Current projects aren’t ramping up as expected and increasing debt levels and operating expenses are plaguing this oil and gas company. Thomson Reuters StarMine data indicates OGX Petroleo earnings are under stress.

OGX Petroleo (OGXP3.SA) is the brainchild of Brazilian billionaire Eike Batista — and one of the biggest oil and natural gas exploration and production companies in the country. However, OGX’s fortunes have been sliding faster than a spreading oil slick.

According to this Reuters News story , Fitch on May 17 downgraded OGX debt after it agreed to spend about $540 million to buy and develop 13 Brazilian oil and gas exploration blocks that it picked up at a government auction on May 14.

Fitch cut OGX’s issuer default rating to “B minus” from “B” and the rating on $3.7 billion of notes sold by its Austrian subsidiary to “B-minus/RR4” from “B/RR4”. The block purchases will put pressure on OGX cash as the company struggles to get its existing, underperforming offshore oil wells to produce more revenue, Fitch said. On March 31, OGX has $4 billion of debt and $1.1 billion of cash. ($1 = 2.0365 Brazilian reals)

Problems like these have cut Batista’s net worth to about $10 billion from just over $30 billion in early 2012. In the same period, OGX stock has fallen from over 12 Brazilian reals (BRP) per share to just under 2 BRP. So is the stock cheap now? Not according to the StarMine models.

Poor scores on most StarMine models

Poor Earnings Quality

OGX has the weakest possible score of 1 on the StarMine Earnings Quality (EQ) model, which indicates that earnings may not be coming from sustainable sources. For example, in the chart below, the company has seen capital expenditures of over one billion BRP over the last three quarters, far exceeding cash flow from operations.

OGX continues aggressively to expand operations — but current capital expenditures are not being funded by operations. The company continues to see negative free cash flows (see chart below), and is still not profitable. Earnings that are not backed by free cash flow tend to be less sustainable than those backed by strong free cash flow.

cap ex
free cash
Source: Datastream Professional/StarMine

Poor Credit Quality
The combination of long term and short term debt has ballooned to over 8 billion BRP despite OGX being debt-free just two years ago. OGX scores the lowest possible score of 1 on the StarMine Combined Credit Risk (CCR) model, the most comprehensive StarMine credit model. It assigns an implied credit rating of CCC+ to the company debt and incorporates three other StarMine credit models:

1) Structural Credit Risk (SCR) model, which evaluates the equity market’s view of the company’s credit risk. The company scores the weakest possible score of 1.

2) SmartRatios Credit Risk (SRCR) model, which uses the company’s profitability, leverage, interest coverage, liquidity and growth to model the credit risk. The increasing debt burden, interest burden and lack of profits explains the low score of 1.

3) Text Mining Credit Risk (TMCR) model, which scans transcripts, Reuters news articles, filings and select broker research to identify key words that may indicate negative news sentiment. OGX is in the bottom decile of companies in the region with a score of 8.

Source: Thomson Reuters Eikon/CreditViews

Analysts not so bullish

The company is not expected to achieve profitability in 2013, with the earnings consensus for the year at -0.16 BRP per share. For 2013, revenue, EBITDA and EPS estimates have been brought down by 41%, 115% and 143%, respectively. Estimates for 2014 also have been cut. The chart below shows just how bearish analysts have become. There are now just two buy recommendations, six sell recommendations and one strong sell recommendation. Just 90 days ago, there were three strong buy and seven buys and only three sell recommendations for the company. Continuing its weak scores, OGX rates a 1 on the StarMine Analyst Revisions Model (ARM).

Recommendation History

Uncertain future
What’s the outlook? OGX continues to spend money on new projects while it sells stakes in existing assets to raise money — and looks to cut costs. It is likely to tap the equity or debt markets to fund future projects. However, with the stock down more than 80% in the last year, and the company’s credit quality suffering, it may no longer be easy to raise large amounts of cash — and owner Eike Batista’s deep pockets are a little less deep. All these factors point to an uncertain future for OGX.

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