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Summary

  • The company has posted a solid quarter which is indicative of good things ahead.
  • The shares have declined significantly this year due to lack of trust on local government policies.
  • We believe the future holds good things for the company with an expected decline in imported volume of oil.

Investors have stayed away from Petrobras (NYSE:PBR) due to continuous state intervention in the company affairs. The government has offered large subsidies to the general public which has been catastrophic for Petrobras. This is primarily because the company imports a major chunk of its product, which essentially means that the company pays for these subsidies from its own pocket. In our previous report we discussed this dilemma in more detail.

This negative investor sentiment is supplemented by the persistent decline in its shares. Petrobras has reported an approximate 18% decline in share price year to date. However, despite these issues we believe that the company is a solid investment.

The company has recently published its fourth quarter earnings and reported a 69% increase in net income (amounting $2.6 billion) while its revenues increased by 3%. This shows that the company's downsizing policy, which we discussed in our previous report, has started to show positive results. Furthermore, we believe that the increase in revenue is fueled by the year-end increase in prices of gasoline (4%) and diesel (8%). This is also reflected by the fact that production levels did not change much, from the third quarter to the fourth quarter, while there was still an increase in revenues.

This was a major positive to draw from the recently concluded quarter but it was still not enough to cover the international and domestic price level gap. During the fourth quarter the international and domestic price level gap was still 11% for gasoline and 19% for diesel. The best way out of this for the company would be to increase production levels in order to decrease its import of oil and diesel as the price level will be restricted by the Brazilian government for the medium term to control the inflation rate.

"The price adjustments were quite important to minimize the effects of losses from Petrobras's imports," said Lucas Brendler, an analyst at Geracao Futuro Corretora in Porto Alegre, Brazil. "When you have an increase in gasoline prices here you reduce your gap with global prices,"

Source: Bloomberg

New Ventures

Petrobras announced on 20th Feb 2014 that a new well, 9-SPS-77 located in the pre-salt Sapinhoa Field in Santos Basin, has been brought online which means that the company's production will increase for first quarter 2014. This well has the capacity to produce 33,000 barrels per day and is linked to Cidade de Sao Paulo, a floating production storage and offloading unit (FPSO). The company has already connected two wells to the FPSO using a riser support buoy (RSB) system and expects to install two buoys at the Sapinhoa field and two more at the Lula field. After these successful installations the company expects both fields to reach combined peak production levels of approximate 120,000 barrels per day. All these installations are expected to be completed by the end of the second quarter of 2014. Petrobras has a 45% stake in the Sapinhoa field and a 65% stake in the Lula field.

Capital Expansion

A major concern for the company is the consistently rising debt level. The debt was around $72.8 billion in 2011, $88.6 billion in 2012 and had increased to an alarming $106 billion by the end of 2013. We believe that debt levels will increase further in 2014 and 2015 due to planned investment worth around $220.6 billion between 2014 and 2018. Around $206.8 of this mammoth capex is for ongoing projects while $13.8 billion is for projects that are currently in the evaluation phase. These investments are expected to increase the company's production level to 3.9 million barrels of oil, natural gas liquids and natural gas per day. With the increased production level, we should expect that the company will have to decrease its import of oil and diesel which will, in turn, play a major part in reducing the negative impact of the difference between local and international price levels. Petrobras has announced that the debt level will reach its peak in 2015 after which it will start to decline.

FIFA World Cup

2014 is an important year for Brazil and for Petrobras as the country is hosting the FIFA World Cup. Due to the mega event there will be a huge influx of tourists which will increase the demand for gasoline and diesel. This will put more demand pressures on Petrobras and should, in theory at least, also drive up the prices of gasoline and related products. However, this will largely depend on how the government wants to deal with rising inflation rates due to an influx of tourism. Either way, Petrobras needs to increase its production to reduce its reliance on imports. The four buoys at Lula and Sapinhoa fields contributing 120,000 barrels per day will be effective in this regard.

Elections

A bigger concern for the company is the upcoming election. Every time a new administration takes charge it appoints a new CEO. After being elected President, Dilma Roussef replaced Petrobras' CEO Jose Gabrielli with Maria das Gracas Foster. If the current administration stays in power we should expect a continuation of current policies and that will be in the best interest of investors. While still a factor, it is not a game changing one because Petrobras is operating globally with multiple companies, either as an operator or having stakes in the project. This means that the only thing that the Brazilian government has influence over is the domestic price and import levies. With an increased reliance on local production the company is already reducing its reliance on imported products and, therefore, will be shielded in the long run from any radical changes in political policies.

Valuations

Amount in $ (billion)

Market Capitalization

73.9

LT Debt

106

Cash and cash equivalents

(15.9)

Enterprise Value

164

The enterprise value of the company is $164 billion and the outstanding shares are 6.52 billion. From this we can calculate an EV/ share of roughly $25.15 per share. The target price estimated by analysts is $19.44 per share. Both these valuations show that the stock is being sold at a major discount.

Analysis

Petrobras is investing substantially in existing and new projects which will increase the production level of the company to 3.9 million barrels of oil. Higher production means that it will significantly reduce its reliance on imported products and decrease losses caused by government subsidies.

Furthermore, demand for oil in the domestic market is expected to increase due to an influx of tourists for the FIFA 2014 World Cup and the 2016 Olympics, indicating that the sales volume will go up. The key point here is the government's attitude toward increased inflation caused by these major events and its domestic pricing policy. While this is a legitimate concern we believe that this risk is only limited and will be significantly eliminated as Petrobras' imported volume goes down in the next couple of years. Therefore, we believe that PBR is a sound investment at these extremely low levels and will bounce back significantly in the next couple of years.

Source: Petrobras Is Improving As An Investment

Additional disclosure: Equity Flux is a team of analysts. This article was written by our Basic Material and Financial analyst. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.