Petrobras: The Best Oil Stock Remains Hidden In The South

Summary

• The Brazilian state-owned integrated oil and gas giant is a dividend powerhouse and a free cash flow machine that is a worthy addition to any income-oriented investor's portfolio.
• Petrobras seems to be trading at a discount, being undervalued both in terms of the industry and the broader market.
• Investors are eagerly awaiting the government's decision as the speculation about the privatization of the company is getting louder.

Wagner Meier/Getty Images News

Petróleo Brasileiro S.A. - Petrobras (NYSE:PBR) - is a dividend powerhouse and a free cash flow machine that has a lot to offer to its potential investors.

The company seems to be undervalued both in terms of the industry and the broader market, being traded at increasingly attractive valuations.

While the Brazilian state-owned integrated oil and gas company is probably not one of the best investment opportunities of the year, it might be just the investment that oil fond income-seeking investors were looking for.

Overview of the company

Petróleo Brasileiro S.A. is a Brazilian majority state-owned company that is one of the largest producers of oil and gas in the world, primarily engaged in the exploration, production, refining, and energy generation.

The company that was founded back in 1954, now controls significant oil and energy assets in 16 countries across Africa, North America, South America, Europe, and Asia.

source: 2021 Q3 Earnings Presentation

The attractive dividends

The Brazilian oil giant is currently trading at $10.77 for the ADR shares, which is resulting in a very attractive difficult-to-say no to 8.49% dividend yield.

For the current year, with the 22nd of December payment included, PBR has already pledged to pay out $2.07 in terms of dividends to the ADR shareholders, which would actually result in a 19% dividend yield. However, one thing should be kept in mind.

source: Investor Relations - Dividends

As defined within the company dividend policy, management is committed to paying out $4 billion in dividends for years in which Brent trades above 40$/bbl, with several different predefined adjustments depending on business results. So in fact the guaranteed, or better said expected dividend yield should be significantly lower. Anything the company can deliver on top of that would be wise to be considered a bonus that shouldn't be expected.

source: TIKR Terminal

As we can see, dividend safety is quite assured in terms of fundamentals. The company is a free cash flow machine. However, it is worth keeping in mind that management has a way of cutting dividends in times of trouble. Still, I would say that the main issue the company is facing is the matter of debt. If the dividend cut is coming, or at the very least if management is holding back on the dividends, it is because of the huge debt level the company carries. We will touch on that matter later in the analysis.

For international investors seeking dividends, it is worth having in mind that Brazil is in the process of reforming its tax system, where non-resident investors would be affected.

The reforms should see dividend withholding taxes raised to a 20% flat rate unless defined differently by dual tax treaties. This somewhat changes Brazil's outlook as an investor-friendly country.

Issues with debt

As it was mentioned before, the main issue affecting Petrobras is the level of its debt. The company has a long and outstanding issue with the level of debt it carries. It is worthy to keep in mind that we are dealing with a $70 billion market cap company that carries almost $50 billion in total debt. This issue was even worse only two years ago when the company held a total of $100 billion in debt.

source: TIKR Terminal

However, through a long and costly deleveraging process, Petrobras managed to slowly deal with the level of indebtedness. With the recent change of fortune in terms of oil prices, this goal seems more achievable than ever.

As per the latest Q3 2021 Earnings Report, management was successful in keeping up with the good trends in terms of deleveraging. The company's net debt went under $50 billion for the first time, with the total debt still in the $59 billion range.

source: Investor Relations - Debt Section

The company carries a somewhat problematic credit rating. Currently, it holds a BB- rating by Standard & Poor's, a BB- rating by Fitch, and a Ba1 rating by Moody's. That would mean the company floats in the lower range of the "investment rating scale" and would be defined as non-investment grade.

Possible privatization is ahead of us?

Earlier this year, the Brazilian government has made several major steps ahead in the process of the privatization of Eletrobras (EBR), the state-owned utility company.

Brazilian senators have approved a bill that allows the government to raise almost 60 billion reais or close to $12 billion by selling their majority stake in the state-owned utility company. The government plans to end its 61% majority ownership of the company by diluting its share base down to 45% or less of the state-owned company.

There has been speculation that the same fate awaits Petrobras after the government completes this process. Brazilian President Bolsonaro was quoted saying that privatization is: "on their radar". Still, the oil company's formal stance on the matter is that there are no plans set in place currently for the privatization process.

If the government brings the privatization process of Eletrobras to a successful end, it is not unreasonable to expect that a similar fate could be expecting Petrobras as well. The market would most likely welcome such a decision, but it is important to keep in mind that the privatization could be a long a politically expensive project with no guarantees of success.

Valuations and competitors

One of the most interesting things about Petrobras is its increasingly attractive valuation. Let us take a look at some of the better-known oil stocks and how well do they compare to our company.

source: Author Spreadsheet

We can see that Petrobras is trading at very attractive valuations at NTM P/E of x4.81 and NTM MC/FCF of x3.18. Its current market cap of just $69.22 billion indicates there is a lot to go on the upside. The current Total Enterprise Value is set at 116.81B. Even with a lot of debt it carries, it trades at interesting NTM x1.25 TEV/Revenue and x2.67 NTM TEV/EBITDA, which is still a lot more interesting than the competition. Furthermore, the company offers a current FWD dividend yield of 8.49%.

Exxon Mobil (XOM) for example is currently valued at a $253.34 billion market cap. It sells at an NTM P/E of x9.35 as well as an NTM MC/FCF of x9.20. It commands an x1.03 NTM TEV/REV and an x5.30 NTM TEV/EBITDA. Exxon Mobil's FWD dividend yield is set to 5.88%.

Chevron Corporation (CVX) one on the other hand is being valued at a $217.58B market cap. It trades at an x1.40 NTM TEV/REV and x5.04 NTM TEV/EBITDA. With the expected NTM P/E of x11.00 and NTM MC/FCF of x7.89, our company is still coming out at the top. Chevron currently has an FWD dividend yield of 4.75%.

BP (BP) is the company with the most similar valuations to PBR. With a market cap of 85.42 billion, it trades at an x0.74 TEV/REV and an x3.72 TEV/EBITDA. All of that is going for an NTM P/E of x5.87. With it yielding an FWD dividend yield of 5.05%, Petrobras still seems to be a more attractively valued investment.

From the direct comparison, we can see that Petrobras is trading at a discount and that the company seems undervalued to both the industry and the broader market.

Risks to keep in mind

If you plan to invest in the company, there are several things that you should keep in mind:

• Possibly worth knowing is that Brazil is finding itself in a rather complex and difficult political environment that can negatively affect the business.
• In the end, Petrobras is mainly in the oil business, thereby the success and profitability of the company are always going to follow oil prices.
• The world is on a slow but steady shift away from oil to renewable sources of energy. This process is probably going to take longer in South America, but it is a fact nonetheless.
• Brazil is in a process of reforming its tax system which is going to result in increased dividend withholding taxes for most international investors.
• With the fears of the new Omicron variant on the rise, it is worth keeping in mind that the demand for oil and gas during lockdowns is bound to take a nosedive.

Final thoughts and conclusions

If one is looking to expand his dividend portfolio and is particularly fond of oil stocks, Petrobras is definitely a worthy addition that has a lot to offer. Still, the world's transition to renewable energy is bound to make an impact on PBR's long-term total returns. However, the company remains to be a cash flow machine and a dividend powerhouse that is capable of creating significant returns for its investors in the short to mid-term.

The speculated privatization is just an additional benefit the investors should keep in mind. Even if it is greenlighted today, the process would not finish in years, and the fundamental impact on the business would take even longer. However, just like in the Eletrobras situation, we could see the shares of the company immediately trading higher if such a decision would be announced.

Another reason why Petrobras is preferable to some other oil companies is that Brazil is not witnessing the same push for environmental friendliness as can be seen in the cases of countries like the United States, Netherlands, or Great Britain. This is mainly due to the country's somewhat difficult socio-economic situation. However, this is a good thing for oil investors.

With everything that has been said, PBR is probably not one of the best investment opportunities of the year. Nonetheless, the Brazilian oil giant seems to be offering a lot of bang for the buck and deserves to be considered a valuable addition to your dividend portfolio.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Comments

[party2998]

What's the difference between PBR and PBR.A? The latter is trading 9% lower. How different is the market liquidity of both tickers? Thanks for your help.

[Prezzo giusto]

@party2998 : Don't be lazy and read this article, then you 'll know :
seekingalpha.com/...

[party2998]

@Prezzo giusto Thank you!

[Prezzo giusto]

Other divestment :
Rio de Janeiro, December 23, 2020 - Petróleo Brasileiro S.A. – Petrobras, following up on the release disclosed on 02/19/2021, informs that it signed today with Carmo Energy S.A. a contract for the sale of all its stakes in a set of 11 concessions of onshore production fields, with integrated facilities,
located in the state of Sergipe, jointly denominated Carmópolis Cluster.
The sale price is US$ 1.1 billion, of which (a) US$ 275 million as a down payment; (b) US$ 550 million at the closing of the transaction and (c) US$ 275 million 12 months after the closing. The amounts do not consider adjustments due until the closing of the transaction, which is subject to compliance with
certain precedent conditions, such as approval by the National Petroleum, Natural Gas and Biofuels Agency (ANP).

[OffSiteLocation]

Enjoyed the nice 10% dividend check yesterday!

[Crevalon]

@OffSiteLocation how much per share did you recieve?

[OffSiteLocation]

@Crevalon a little leas than $1.10 I recall.

[Crevalon]

@OffSiteLocation likewise 1.08 USD net per share

[Pops007]

www.reuters.com/...

Brazil hiking rates.

[crrj]

What if communist and Lula win next year???? Communist oversaw regulating VALE dams that burst-----

[asm12345]

@crrj That's why you pay attention to what's going on and make a call on whether PBR is a trade to make a quick buck, or a long term hold. We should have a better idea in the next few months which it will be.

[Liberum Mercator]

"The world is on a slow but steady shift away from oil to renewable sources of energy. This process is probably going to take longer in South America, but it is a fact nonetheless."

It is not. What is actually happening is that for some reason the world is hell bent on making practical and economic energy sources (broadly speaking nuclear and fossil fuels) illegal and replacing them with unreliable and utterly impractical meme technologies. This will either come to an end, or it will destroy our entire civilization.

Good article other than that. An introduction of the alphabet soup of financial ratios might be a good addition for clarity. E.g. "NTM TEV/REV" = ?

[DIV12]

@Liberum Mercator Total Enterprise Value/ Next Twelve Months Revenue

[OffSiteLocation]

What holds pbr back is uncertainty. Govt uncertainty in terms of taxation, ownership, and dividends payable. Sadly I don’t see this changing. But am am long as the discount relative to uncertainty is more than there should be imo.

[huskers123]

I can make a case the Dems and Biden are more dangerous for US oil than Brazil’s government is to PBR. They are making substantial debt reduction at the same time returning 50% of free cash flow. Very cheap. Brazil should use their dividends to give a break at the pump. Should be elated getting the $$$. But you never hear of them doing that only whining about the dividends everyone else gets…lol

[PianoCat]

@huskers123 Gasoline futures closed at $1.96/gallon yet gasoline costs $5/gallon in California. Some are due to transportation cost but most of the difference is due to taxes, fees and environmental regulations.

It’s actually very simple if they want to reduce gasoline prices - cut those taxes and fees. But Dems will never lower taxes. Instead they demonize American oil companies.

[huskers123]

@PianoCat exactly!!!

[Lightnotheat]

@PianoCat when was the last time you saw any politician cut fuel taxes? Never. Because they all love the regular, repeatable revenue that targets absolutely everybody.

[Troutbum41]

Does anyone have thoughts on the talk of privitization. I realize it is political, but my sense is that it is more a political talking point than a real possibility. The government siphens off too much money from PBR to ever let it go private in my opinion. Thoughts anyone???

[PianoCat]

@Troutbum41 It’s too cheap to privatize. The government would be stupid to sell at such basement prices.

[atlantic51]

@Troutbum41 it is interesting to remember that not long after the massive corruption scandal of the Lula government, Lava Jato, had been uncovered, an opinion poll showed that a majority of Brazilians were still against a full privatization.

[atlantic51]

@PianoCat should the government announce that it plans to really privatize, the stock would take off because what is holding it back is governance concerns.

[asm12345]

Ive got a pretty decent sized position in PBR. Amazing dividend and as long as Brazilian politics doesnt get too crazy, deeply undervalued. PBR is a buy so long as you watch the presidential race down there.

[atlantic51]

@asm12345 Put it another way, it is an interesting trade; it will become a long term buy IF it is fully privatized, which remains doubtful.

[zip6485]

Oil an gas are the best forms of energy.
Russia is laughing her ass off right now.
Long PBR-A.

[Chancer]

@peter Mirkovic:

Thanks for article.

IMO, if leftist Lula is elected president in 2022, I doubt that privatization will occur, as he would definitely kill it regardless of the status.

For U.S. investors, most countries have tax treaties with the U.S. limiting withholding (WH) tax to 15%; and you can deduct a credit on your tax return for WH taxes paid.

With PBR there is considerable risk, but the dividend potential may be worth that risk as long as the prospect for higher oil prices continues. For me, uncertain government involvement in PBR is the greatest risk as politicians can act in irrational and often unpredicted ways.

[zip6485]

@Chancer ,
In politic, crazy things will happen, everyone said Mrs. Clinton would win 100% too. I have not written off the present guy yet. Once a crook, always a crook, Lula is a crook, a corrupted crook.

[Chancer]

@zip6485:

Corrupt. yes. However, the courts in Brasil over turned his criminal conviction. Bribery of judges in So America is often done. I know because I lived in So. America. Both sides bribe the judge, so he passes case to another judge, who also collects bribes from both sides.

[hdhntr1]

@zip6485 Isn't saying that he is a politician and corrupt redundant?

[atlantic51]

I think that privatizing Petrobras is a lot more challenging than privatizing Electrobras: PBR makes a lot a profits which governments like to control, and even among the population, PBR strikes a emotional cord that EBR doesn’t.

[Russom]

PBR is a good bet but…..
by the last quarter of next year we have presidencial elections (governors pe and 1/3 of the senators) so forget of any new privatizations approvals which is a controvertial issue always)
If the criminal Lula is elected Petrobras CEO and the board of directors will be replaced and….????
Brazil is not late regarding environment friendless but ahead as half of the gasoline needs has been replaced by etanol and 10% of the diesel by biodiesel, while 70% of eletrical power is hydro, almost 17% is solar/wind, 5% is biomass and natural gas

[Liberum Mercator]

@Russom Is dispersed, dilute, land- and raw materials-hungry biomass, solar and wind harvesting actually more "environmental" than high-energy density fossil fuels and uranium?

Probably not.

[mog123]

@Liberum Mercator just keep telling yourself that and never, ever think that a pollution cost will land on a balance sheet.

[Liberum Mercator]

@mog123 I'm not telling myself anything. Unreliables consume many orders of magnitude more land and raw materials than fossil fuels or nuclear. This is reality.

What is the environmental value in destroying all that land and massively increasing the world demand for steel, concrete, copper and rare earths if it just makes electricity unaffordable and unreliable?

[cenc]

Yea, just keep one eye on the election coming up. latin american politicians like to raid state owned companies to buy votes.

[chali]

Post debt reduction PBR is a giant cash machine.

[Finans2016]

@chali remember that real debt (banks and bonds) is only around 35bn, and the rest is purely ISFR-accounting from the long term lease agreements.

[atlantic51]

@chali yes, the question is how that cash will be spent.

[PianoCat]

@atlantic51 That cash can either go to dividends or capex/acquisitions since they don’t plan to reduce debt any further.

[alextay]

I believe there were mentions that the withholding tax bill was killed ?

[PianoCat]

@alextay Can you link it? 15% tax on dividend is tough to swallow with a stock yielding 20%+

[zip6485]

@PianoCat ,
I know Canada withholds dividends tax for Ex-Canadians 15%,Israel withholds 25%. Since both countries have tax treaties with US, Uncle Sam
gives us back by tax time.

[alextay]

@PianoCat I saw it in one of the comments to the previous PBR article. Can’t confirm it, so am asking whether anyone has more robust information on this.. thanks

[PianoCat]

It looks like PBR will pay around $1/quarter of dividend if Brent stays above $70. PBR’s most recent presentation assumes that Brent gradually drops to $55 in the next 3 years, which I think is overly conservative. But even with that expectation they plan to pay out $60B to $70B of dividend in the next 5 years, giving a dividend yield of 20%.

I believe PBR is rated BB- because Brazil’s sovereign credit rating is BB-. So there’s no hope of ever getting to investment grade. Still, PBR gets to borrow at 5% interest rate for 30 year bonds which isn’t too bad.

[atlantic51]

@PianoCat If I remember, PBR had a higher debt rating than the country during the debt crisis of the 1980s.