Petrobras Turn of Fortunes

02 Oct 2017

  • Petroleo Brasileiro (aka Petrobras), is one of Latin America’s largest companies
  • The company has turned itself around after being embroiled in the high-profile  “car wash” scandal in 2014
  • We hold an overweight bond position given the strong strategy in place, and the company’s ability to manage through the low oil price environment

Petroleo Brasileiro (aka Petrobras), a Brazilian oil and gas company formed in 1953, is one of Latin America’s largest companies. The Brazilian government is the largest stakeholder, but the company is also listed in Sao Paulo and New York, with many ordinary Brazilians among its shareholders. In 2014, the company became embroiled in a scandal. It was alleged that top Petrobras officials colluded with a cartel of 16 companies to overcharge Petrobras for construction and services work in return for kickbacks and bribes. The scandal was far reaching and the then Brazilian president, Dilma Rousseff, whose election campaign had promised to reduce corruption, was impeached. Former president Luiz Inacio Lula da Silvia was also implicated in multiple corruption scandals.

The company has since risen from the ashes and turned itself around. For instance, its current deleveraging program could possibly trigger further upgrade as the company continues to prove itself to ratings agencies. Already in April this year, Moody’s upgraded Petrobras’s rating to B1 with positive outlook, from B2, stable outlook. Moody’s attributed Petrobras’s improvement in its liquidity profile and financial metrics to cost efficiency and new fuel pricing policy. In addition, they also highlighted developments in the Brazilian regulatory environment, facilitating long term investments, and its management commitment in achieving financial and operating targets. Most importantly, Moody’s stated that the positive outlook indicates further positive rating actions in the next 18 months if their liquidity and overall risk continues to improve.

We remain constructive and positive on Petrobras, even as it faces both external and internal challenges. We expect Petrobras to continue to reduce its leverage to a target of 2.5x as it realises sales of noncore assets, maintains minimal capex and enters new joint ventures (JVs) providing cost efficiencies and predictable cash flows. Capital markets look set to continue funding Petrobras, at least in the short to medium term, due to its proven discipline in navigating through the low commodity cycle. However, in order to improve, Petrobras will also need to pursue its sale of non-core assets, establish JVs guaranteeing improvements in production and cashflows, and maintain low(er) capex.

Still challenging for Petrobras is the low commodity environment which is adversely affecting Petrobras’s income and cash flows. This is an external factor beyond their control. Further weakness in commodity prices and global demand growth could also challenge our fundamental outlook. However, the company has demonstrated its ability and willingness in adjusting to these challenges by turning off high cost fields, opening up to partnerships, and selling non-core assets. The main internal risks are potential corruption cases and high pension liabilities, although we do not expect any material surprises on the corruption cases and have seen the company take steps in addressing its pension liabilities.

Due to the public holiday in the US, the Fixed Income Weekly will not be published on Monday, October 9. The next issue will be delivered on Monday, October 16.

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