We covered Petroleo Brasileiro S.A. (PBR.N), on June 17, noting the company’s challenges — a recent political scandal and the steep decline in global oil prices. Since that report, we’ve seen further evidence of possible company malfeasance with the heads of Brazil’s two largest construction firms being arrested in connection with the unfolding scandal.
The company announced on June 29 a new investment budget, slashing five-year investments by 41%, equating to a whopping $76 billion and, just to ensure executives remain busy, PBR is also facing a class action from irate U.S. shareholders over its bribery/corruption scandal.
Source: Eikon
Divestment plan impact
Let’s focus on the investment plan, where PBR (as anticipated) significantly scaled back its capex but, more unexpectedly, also announced potential divestments of up to $15 billion as part of the restructuring. The market reaction? Relatively muted, with the share price fall in line with global index declines as the market digested the news of a Greek referendum. Analysts are clearly taking time to digest the business plan and determine its impact on EPS, since cost cutting will help with bottom line earnings, but it seems safe to assume a reduction in capex will also have repercussions on longer term growth.
Source: Eikon
Sharks in the water?
Another warning sign for the company is the poor StarMine score for Short Interest, which places PBR in the bottom 3% for U.S. stocks (I’m referring to the score for their ADR). Put simply, this means a large amount of stock has been sold short, indicating institutional/professional investors are anticipating further share price declines. Other oil majors such as XOM or BP don’t seem to have such large short positions so this appears to be specifically focused on the company rather than the sector. Note the low level of institutional ownership overall, as PBR’s majority shareholder is the Brazilian government.
Watch the cash flow
The other area of continued investor focus is the heavy debt load the company maintains. The reduction in capex is clearly a reaction to that. There are two concerns that the company really cannot address here – the first is that much of PBR’s debt is denominated in USD. That means the company is exposed to the fluctuations in the Brazilian real – and emerging market currencies are not exactly in vogue this year. Secondly, the company, of course, is exposed to the global oil price – again something management simply cannot control.
Source: Eikon
Spending Cuts
Understanding this background, it becomes much easier to comprehend the reduction in spending over the next five years and the soothing words about ensuring current investors are not diluted with any form of equity raising (which would lower the firm’s leverage ratio, appeasing nervous bond holders).
Source: Eikon
Cloudy outlook
So PBR continues to respond to its numerous challenges – senior executives are doing what they can, pulling on the levers that are under their control. Ultimately, boom time debt may come back to haunt them, if either EM currencies or oil prices sag further. The StarMine credit scores tell the story, as do the 11 holds and 3 sells from within current analyst coverage. For those with a bullish view on oil, the BRL or both, this looks like a great leveraged play. However for the traditional stock picker – there are an awful lot of variables beyond the company’s control. Stay tuned.
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