Among the names above, Petrobras hurt returns the most. The company’s shares continued to suffer as a result of a number of factors, including the economic situation in Brazil, a corruption scandal and a recent debt downgrade. While we recognize that the risks to our investment continue to be elevated given Petrobras’ levered balance sheet, high incremental funding needs over the next five years, current low oil price and the uncertain political environment in Brazil, we believe the risk/reward tradeoff remains attractive at the company’s current valuation. Over the longer term, we see a number of reasons for optimism, including:
- Petrobras (NYSE:PZE) continues to have a tremendous and valuable asset base. Our analysis suggests that the market is valuing Petrobras’ proven resource base at a substantial discount to our estimate of its true worth.
- In recent months, the company has announced a medium-term strategy with specific plans to improve its balance sheet, including cutting capital expenditures and using asset sales to reduce leverage. Additionally, governance and transparency appear to be improving.
- Petrobras recently instituted a much needed increase in domestic gasoline and diesel prices. The move contributed to the recent profitability and positive cash flows for the company’s downstream segment, and alleviated pressure from weakness in the Brazilian real of late. Furthermore, this event helped ease concerns that the Brazilian government would forbid fuel-price increases.
- Increased production from the company’s pre-salt assets (large oil basins in deep waters off Brazil’s coast) could improve upstream profitability over the long term.
- We believe additional capital expenditure cuts are possible if oil prices decline further and/or the economic situation in Brazil deteriorates.
From the Brandes International Equity Fund letter for the year ended Sept. 30, 2015.
