Petroleo Brasileiro S.A. (PBR, Financial), better known as Petrobras, stands as a behemoth in Brazil's oil and gas sector, holding sway over the nation's economy as the largest state-owned company. Its operations span the entire oil production chain within Brazil, excluding distribution, and it also has a stake in the natural gas sector, alongside ownership of numerous thermoelectric plants.
In recent years, Petrobras has honed its focus on the exploration and production segment, particularly in the pre-salt region, which has been a major profit driver, contributing a significant 80% of the company's net profit over the past three years. Its robust operations in this area form a pivotal aspect of its growth narrative.
What sets Petrobras apart is its competitive extraction costs in the pre-salt region, which make up 78% of its oil production. This strategic advantage translates into lower extraction costs per barrel compared to many international oil companies. Furthermore, the pre-salt reserves offer high-quality, light crude oil, adding to its allure.
However, amidst these strengths lies a sizable challenge. Petrobras finds itself entangled in a significant struggle, with minority shareholders potentially facing losses in the open market. Governance issues, inherent in many state-owned entities, have plagued the company, exacerbated by recent shifts in pricing policies, stalled divestment plans and alterations to its dividend policy. These developments have cast doubt on Petrobras' long-term viability as a reliable income stock.
In this article, I delve into the latest developments surrounding Brazil's corporate giant, shedding light on governmental conflicts concerning dividend policies and investments. I also explore why, given the prevailing circumstances, I have opted to withhold investment in Petrobras for the time being.
Latest results
Following Petrobras' latest quarterly results in March, the stock experienced a significant decline, primarily attributed to news regarding its dividend. Despite considerable volatility a month later, the stock has recovered all losses. Nonetheless, the company remains entangled in numerous issues, leaving investors uneasy.
In 2023, Petrobras achieved its second-best bottom-line results in history, generating Ebitda of $52.40 billion. Despite the lower average oil prices compared to 2022, the company reported an operating cash flow of $11.85 billion and a net profit of $6.42 billion. These figures surpass international private oil peers, including Equinor (EQNR, Financial), BP (BP, Financial) and Occidental Petroleum (OXY, Financial).
Source: Koyfin
Despite robust fourth-quarter results, the 10% drop came at a bad time. Brent crude oil prices experienced a significant decline, falling by 20% compared to the third quarter, and production decreased by 300,000 barrels of oil equivalent per day.
Dividends
One crucial aspect is that a significant portion of Petrobras' Ebitda is converted into cash, enabling the company to pay substantial dividends.
Petrobras's dividend policy—changed last year—is based on the condition of its gross debt, which should be up to $65 billion. Currently, the debt stands at $62.40 billion, allowing the company to distribute 45% of its free cash flow to shareholders. This represents the difference between the company's operating cash flow and investments. If there is no use for this surplus cash flow, it can be used to pay dividends.
The market expected Petrobras to pay extraordinary dividends of $3 billion to $4 billion. Still, the company retained this money on its balance sheet, which is concerning. This has led to questions about how it will use these funds, whether for investments in renewable energy, acquiring refineries or purchasing stakes in other companies, such as the petrochemical Brazilian company Braskem (BAK, Financial), of which Petrobras already holds 36% of its shares.
Even if Petrobras uses these resources for strategic investments, it should still be able to distribute dividends equivalent to roughly 10%. This distribution would be significant, surpassing the average of large oil companies abroad.
| Company | PBR | BP | EQNR | OXY |
|---|---|---|---|---|
| Dividend Yield (FWD) | 9.83% | 4.44% | 5.16% | 1.31% |
| Dividend Yield (TTM) | 4.08% | 4.34% | 4.42% | 1.13% |
| 4-Year Average Yield | 22.87% | 5.72% | 6.08% | 3.19% |
| Dividend Growth 3 Yr (CAGR) | 54.69% | 2.68% | 19.12% | 166.84% |
Toward the end of last year, Petrobras announced plans to construct new diesel production units at five refineries. This strategy aims to boost fuel processing capacity at its facilities by 229,000 barrels per day by 2029.
In unveiling its four-year Strategic Plan, the state-owned company highlighted this objective could be achieved by introducing new major refinery projects and revitalization efforts at other facilities.
Moreover, Petrobras may not continue to receive proceeds from divestments in the coming years, and there is no indication of a resumption of this practice. The company anticipates halting divestment activities outside the Exploration and Production segment and initiating new investments in renewable assets and those aligned with the energy transition, which is in line with its strategic plan.
This stance by the company in favor of more aggressive investments in refining and other renewable energies, at the very least, undermines the dividend thesis for Petrobras' shareholders.
The governance risk
For investors seeking income stocks, it is crucial the company consistently provides returns to its shareholders. However, recent alterations to Petrobras' dividend policy and strategic investment plan have introduced uncertainty regarding its long-term attractiveness for investors.
Compared to other international oil companies not under state control, Petrobras carries higher risk. Last year, Petrobras appointed Jean-Paul Prates, a former senator from the same party as Brazil's current president, as its CEO. One of the initial actions under this new leadership was discontinuing the import price parity policy. While this policy allowed Petrobras to manage fuel prices via subsidies for social policies, it adversely affected the company's profits.
Amidst increasingly volatile Brent crude oil prices last year, Petrobras found itself trailing by nearly 30% on fuel prices under the new pricing policy at one point. Consequently, the company had to hike fuel prices within the country to mitigate this gap. Hence, there is a significant risk in maintaining alignment with Brent oil prices.
This corporate governance risk is reflected in the company's valuation like the price-earnings multiple, as Petrobras trades at much more discounted multiples than its peers as can be noticed in the table below.
| Company | P/E Non-GAAP (FWD) | EV/EBITDA (FWD) | EV/EBITDA (TTM) | Price/Cash Flow (TTM) |
| PBR | 4.73 | 2.94 | 2.99 | 2.27 |
| BP | 7.94 | 3.29 | 3.12 | 3.32 |
| EQNR | 8.21 | 1.82 | 1.63 | 3.19 |
| OXY | 18.63 | 6.17 | 6.70 | 4.83 |
Corporate governance problems and environmental or political issues have different impacts on enterprise value/Ebitda ratios as well. Since Ebitda measures the company's operational performance, it can be less affected by non-operational factors. Therefore, while corporate governance problems or regulatory investigations can affect Ebitda, they do not have as direct an impact as net income.
Thus, Petrobras' EV/Ebitda ratio is similar to that of some of its main private competitors - and even higher than that of Equinor, for example - even if the price-earnings ratio is higher, reflecting the resilience of the company's operational performance amid these specific challenges. As such, I am a little more skeptical about investing in a state-owned oil company like Petrobras than in a private company with a more stable governance issue and equally exposed to the variations in Brent oil.
The bottom line
There is nothing inherently wrong with Petrobras' fundamentals. The company continues to report extremely robust results, and its core business remains highly profitable despite the backdrop of Brent prices since 2022, owing to its cost-efficient operations in the exploration and production segment.
However, the major concern in the thesis lies in future investments and how much these could drain cash, along with the expected profitability of these projects. Announcements regarding the company's strategic planning in the coming periods are crucial in addressing this uncertainty, especially regarding how it will impact the distribution of dividends.
Given all the risks related to commodity prices and the corporate issues affecting the investment thesis, I no longer perceive Petrobras as priced significantly below its peers for direct investment.
Considering these factors, I am skeptical about the current timing of incorporating Petrobras as an income stock for a dividend-focused portfolio.
