- 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.
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.
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.
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.
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?
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.
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.
This article was written by
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