A Petrobras Bailout Seems Highly Unlikely

| About: Petrobras - (PBR)

Summary

Petrobras has a liquidity position comfortable enough to comply with its obligations due in 2016 and 2017;

Petrobras leads refining in Brazil which should act as a buffer for more challenging exploration and production operations;

In the short-term, an intervention by the state seems a very low probability event but with catastrophic consequences in case of occurrence.

Nearly two weeks ago the President of Brazil, Mrs Dilma Rousseff, stated that a bailout of Petrobras (NYSE:PBR) couldn't be ruled out, adding selling pressure to the stock in an already adverse market environment. However, looking closer to Petrobras fundamentals it seems that a bailout is highly unlikely.

One interesting thing worth noting is how much this company's business profile has shifted in the last two years. Back in 2014 the refining, transmission and marketing business was a clear cash absorber, negative from top line to bottom line. In 2015 the situation reversed, and the segment represented 45% of the gross profit, 54% of EBITDA and will most likely explain the bulk of net income attributable to shareholders when year-end results are released.

Also interesting to see is that refining, transmission and marketing, although representing a large portion of Petrobras profitability due to the nature of the business, only stands for around 20% of assets and 10% of capex. If this area continues to gain importance, it may create room for further asset sales.

Petrobras has a unique position in downstream operations, due to the integrated nature of production. Petrobras leads refining in Brazil and the maintenance of these operations should remain a buffer for much challenging exploration and production, as nearly all of the oil produced by Petrobas is channeled to its refining business, a captive client of the company. Petrobras remains a net oil importer, therefore low oil prices isn't terrible news.

All operating segments of Petrobras are profitable, except for biofuels, which is also a less meaningful segment. With breakeven exploration costs at around 32 USD/barrel on average, still above current prices, funds from operations are likely to reach 24.7 bn USD and 23 bn USD in 2015 and 2016 respectively, according to a pool of analysts surveyed in January this year.

When adding a cash position of 25 bn USD to the 2016 operating cashflow of 23 bn USD Petrobras seems to have enough cash to cover capex in 2016, expected to be 20 bn USD, and pay debt and interests of 18.2 bn USD. In the aftermath, it will free around 9.8 bn USD.

Adding to this 9.8 bn USD, proceeds from announced asset sales including Braskem stake, but excluding Gaspetro (which could amount to further 2.9 bn USD), and available lines of credit totaling 5.8 bn USD, we get around 18.5 bn USD.

With 18.5 bn USD Petrobras should enter 2017 in comfortable enough liquidity conditions to pay debt coming due that year, plus interest, while buying time to adjust its cost and investment structure to the new oil price environment and avoid a government bailout.

Risks to this scenario are the 32 bn USD of unprovisioned contingent liabilities regarding tax, labor, environment and other legal claims (that may not happen and if they happen, probably will be distributed throughout time). This is in addition to further corruption news, and difficulties in selling assets, given that the sector doesn't seem very attractive.

This week the press reported that a judge ruled the sale of the 49% stake in natural gas distribution unit Gaspetro should be halted because the deal did not meet certain transparency requirements, and because of worries that Petrobras may be repeating some of the actions that led to a massive corruption scandal. The company affirms that it is not aware of the referred decision.

The news shows that further noise ahead is likely, however, given the liquidity position of the company, the debt redemption schedule, its dominant position in Brazil and is business profile, Petrobras should have time and space to adapt to a new operating environment and not need an intervention from the state.

If indeed there is an intervention, bondholders will be the main beneficiaries and further dividend suspensions are highly likely. However, if Petrobras equity continues loosing value is up for debate and depends on the timing of the intervention.

If the intervention is needed in 2016 then it would be catastrophic because it would most likely be another case of fraud or corruption. In addition, given the state of public finances, it would have a meaningful impact on the Brazilian economy, which would be very bad news for Brazilian equities in general and Petrobras in particular.

If the intervention happens in 2017 or beyond, then its impact on equity doesn't seem that clear. Such an intervention could be explained by maintenance of adverse conditions in the oil market or incapacity of the company to reduce costs, sell assets and consequently readjust its business profile. On the other hand, Brazilian public finances may be in better shape and probably an intervention wouldn't be perceived as negatively for the economy as a whole as if it were to happen today, therefore it wouldn't be as negative for Petrobras equity.

In my view, Mrs Dilma's words were likely intended to assure investors that a backup from the state to the company in an extreme situation is there, and signal strong support and commitment, rather than concrete need for action.

Uncertainty remains high, and equity volatility is likely to continue affecting Petrobras in the near future. It should also create interesting entry points, although a longer term holding perspective is likely required to keep up with headline noise.

An intervention in the short-term is a very low probability event but with catastrophic consequences in case of occurrence.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.