Last Friday, Petrobras (PBR) announced a 4% increase in its price for gasoline and an 8% increase in its price for diesel. The new prices became effective one day later. The increase is the third time this year Petrobras has hiked prices. In January, it raised gasoline prices 6.6% and two months later increased diesel by 5%. Shares in Petrobras lost about 10% today, the steepest intraday decline since June 2012. While the government has allowed Petrobras to increase prices for the first time since March, the recent announcement fell short of expectations. The company has not yet introduced a new methodology for establishing prices, and once it does, it has stated that it will not disclose any details on how it establishes prices for fuels. This lack of transparency is clearly negative for investors and does not support Petrobras' commitment to align domestic prices for fuels with international benchmarks over the medium to long-term.
Over the past couple of years, the government has interfered in the company's decisions by setting fuel prices which has harmed its financial performance. Due to Brazil's efforts to slow inflation through fixed gasoline prices, it has imposed losses in the company's downstream operations since the beginning of 2011. Since mid-2012, the Brazilian government has corrected part of this situation with 4 diesel price readjustments and 2 gasoline readjustments. The company is still operating at a loss, and this recent price increases does not seem enough to bring downstream operations to break-even.
The gap between Brazil's and international prices for fuels has narrowed with this price increases but is still at almost $10/barrel. This should lead to annual losses of about $8 billion, lower than in the past two years but still too much high. The fuel subsidies caused a loss of $3.7 billion in the company's refining division in the third quarter of 2013 because Petrobras was selling imported gasoline at a discount to international prices. Although Petrobras exports crude from Brazil, it needs to import gasoline and diesel because its refineries can't meet demand. Petrobras' net income declined to about $1.5 billion in the third quarter, its lowest level in 11 years. Its quarter earnings-per-share declined by 39%, the steepest decline among the major oil producers globally.
Petrobras has indicated that it seeks to deleverage its balance sheet within the next two years, but heavy capital expenditures expected and losses in its downstream operation make its goals difficult to achieve. Its net debt reached more than 3.15x EBITDA at the end of the last quarter, its highest level since 2002. The company wants to maintain its investment-grade credit status, and in order to meet this target it has to report a net-debt-to-EBITDA ratio below 2.5x. Although the recent price hikes will help to increase EBITDA, it aren't enough to reach this target in the short-term. Moreover, Petrobras should continue to be free cash flow negative over the following years due to its huge capex plan, making its deleveraging goals to look ambitious.
While higher domestic prices for fuels are positive for Petrobras, the recent single-digit hikes are not enough to make its refining business profitable. Moreover, given inflationary pressures in Brazil, any further increases in fuel prices in the country over the coming months are hard to implement. Thus, Petrobras' downstream operations should continue to report losses over the next few quarters hurting investor's sentiment towards its stock. The fuel losses have helped Petrobras to be the worst-performing major oil stock in the past five years. Therefore, despite Brazil's huge oil production growth prospects, Petrobras does not seem to be the best way to play this theme in the short-term. A good alternative may be Repsol (OTCQX:REPYY) which has a significant exposure to offshore oil fields in Brazil, offers a dividend yield of 5% and is attractively valued, as I discussed in my previous article Repsol: An Undervalued 5.25% Yielder.