- After years of deleveraging that left little room for dividends, Petrobras appears to have finally turned a corner.
- Their free cash flow surged during 2021 thanks to the strong oil price environment and when looking ahead, this should continue with OPEC+ seemingly faltering on their planned production increases.
- This is significant from an organization that historically cheats on production quotas, thereby calling into question their ability to increase oil supply.
- This should support oil prices and thus their dividends with even the relatively modest estimation from Goldman Sachs seeing a massive 30%+ dividend yield on current cost.
- When combined with their now very healthy financial position, it should be no surprise that I believe a bullish rating is appropriate.
The oil and gas industry has not been particularly rewarding for many income investors during the past years, especially the shareholders of the Brazilian major, Petrobras (NYSE:PBR), who have been patiently waiting upon their deleveraging campaign that left very few dividends for most of the last decade. When looking ahead, their dividend outlook appears to have finally turned a corner with investors now offered an opportunity to grab an insanely high 30%+ yield if OPEC+ keeps faltering on its oil planned production increases, which itself appears quite realistic.
Executive Summary & Ratings
Since many readers are likely short on time, the table below provides a very brief executive summary and ratings for the primary criteria that were assessed. This Google Document provides a list of all my equivalent ratings as well as more information regarding my rating system. The following section provides a detailed analysis for those readers who are wishing to dig deeper into their situation.
Image Source: Author.
*Instead of simply assessing dividend coverage through earnings per share cash flow, I prefer to utilize free cash flow since it provides the toughest criteria and also best captures the true impact upon their financial position.
Image Source: Author.
Unlike many of their non-state-controlled supermajor peers, their cash flow performance actually fared surprisingly well during the severe downturn of 2020 with their operating cash flow even increasing year-on-year to $28.89b versus its previous result of $25.6b during 2019. Although this increase was due to temporary working capital movements that if removed, sees their underlying result of $24.93b for 2020 down 15.68% year-on-year versus their previous equivalent result of $29.565b during 2019, which still marks a relatively very strong performance considering the severity of the downturn. When looking at the first nine months of 2021, their operating cash flow has surged thanks to the strong oil price environment, which has seen their free cash flow reach a very impressive $17.897b that even eclipses their annual results during 2018-2020.
Virtually every oil and gas company has enjoyed surging free cash flow during 2021 and thus the far more exciting news in this situation is the resulting outlook for their dividends, given their variable policy. Since the details of their dividend policy have already been discussed by fellow authors in recent months, there would be little point to assess these in detail. The important takeaway is simply that their future dividends will increase and decrease in tandem with the price of oil, given that it will remain the primary factor influencing their free cash flow from which their dividends are calculated.
Despite oil prices being notoriously volatile and vulnerable to economic swings, the background environment appears set for higher prices in the coming years. Whilst the potential impacts of the Omicron COVID-19 variant have dominated the news the past month, the potential impacts appear muted and only marginal, unlike two years ago when the first wave resulted in oil prices briefly turning negative. When combined with the sluggish response to higher oil prices from shale producers, it leaves OPEC+ directing prices for the foreseeable future.
It would be well known by investors who follow the energy sector that OPEC+ members are notorious for cheating on their production quotas, especially when oil prices are in a stronger rising environment that provides a significant reward, such as during the latter half of 2021. Although unlike when oil prices were previously strong during 2018, this time they are not even sticking to their production quota as a whole but actually underproducing significantly with additional supply added between July and December 2021 only coming at 1.2mb/d versus their planned increase of 2mb/d, thereby leaving a sizeable 800kb/d miss.
Whilst their actual spare capacity to increase oil production of many OPEC+ members are state secrets and thus not publicly available, it nevertheless remains possible to make logical judgments based upon their publicly visible actions. Their seemingly faltering performance calls into question their true spare capacity, which by extension calls into question their ability to increase oil supply, regardless of oil prices. At least officially, their spare capacity at the end of 2021 was north of 5mb/d, although if this were the case, then it begs the question of why they would voluntarily forego higher earnings by producing significantly less than already planned, especially given their history of cheating and overproducing. Following the years of suppressed oil prices after the crash in late 2014 that strained their budgets, it stands to reason that years of suppressed investments and natural field decline has withered away a material portion of their spare capacity, thereby now making it difficult to respond to higher price with higher production.
When the seemingly faltering supply response from OPEC+ is combined with the lackluster response from shale producers, it begins seeing why oil prices could continue rallying into the triple-digit levels during the coming years, which echoes the warnings from several investment banks, such as JPMorgan (JPM). Even if only using the relatively modest forecast by Goldman Sachs (GS) that sees Brent oil prices averaging $81 per barrel, they still expect an insanely high 30%+ dividend yield on current cost, although if oil prices continue rallying to over $100 per barrel, this would grow even more astronomical. If this fails to translate into higher oil prices as hoped, the lack of supply response to higher prices should help put a floor under prices and even with Brent oil prices only averaging around $60 per barrel, they still stand to provide a massive dividend yield on current cost based upon their recent capital allocation guidance, as the graph included below displays.
Image Source: Petrobras November 2021 Investors Presentation.
It can be seen that their capital allocation strategy for 2022-2026 expects total dividend payments of $65b at the midpoint, which works out to $13b per annum on average over the five years with Brent oil price assumptions averaging around $60 per barrel, as per slide eighteen of their previously linked November 2021 investor presentation. Given their current market capitalization of only $69.5b, this projects their dividend yield on current cost at a massive near 20%, which is simply amazing for a conservative scenario that actually requires Brent oil prices to decrease materially from their recent circa $80 per barrel level. Even though their future dividends are down to the fate of oil prices, it nevertheless will still be important to assess their financial health following their near-decade-long deleveraging campaign.
Image Source: Author.
Whilst their shareholders have largely gone without any significant returns during recent years, at least this has not been in vain with their debt plunging to $36.716b, which is down massively even as recently as its level of $53.888b at the end of 2020. Thankfully they have maintained their large cash balance that currently sits at $10.919b, thereby leaving their net debt at only $25.797b and whilst this may still sound rather formidable, it should be remembered that they are a massive company producing immense earnings and free cash flow. When looking ahead, their previously discussed capital allocation guidance indicates that their deleveraging days are now mostly over with cash inflows expected to approximately match cash outflows, which is mirrored by their comparable guidance on slide twenty-three of their previously linked November 2021 investor presentation.
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Following their net debt plunging, it was no surprise to see their leverage follow in tandem with their net debt-to-EBITDA of 0.55 and net debt-to-operating cash flow of 0.70 both sitting quite comfortably in the very low territory of under 1.01. This marks an improvement versus their respective results of 1.55 and 1.46 at the end of 2020, which itself already represented improvements versus the end of 2019, which was also an improvement versus 2018. Even if their sizeable $22.892b of lease liabilities were included as debt, their net debt-to-EBITDA would only increase to 1.04 and thus still be sitting around the crux between the low and very low territories, thereby still not materially changing their situation. This sees their financial position in its healthiest position in years, if not ever and thus leaves them poised to capitalize on higher oil prices by providing never before shareholders returns after years of painful deleveraging.
Image Source: Author.
Similar to many of their non-state-controlled supermajor peers, their liquidity has been consistently strong every year, which is aided by their large cash balance and ultimately sees their current and cash ratios at 1.09 and 0.45 respectively. When looking ahead, even if oil prices fail to keep climbing as hoped, thanks to their massive operational size and systemic importance to the Brazilian economy, their strong liquidity should persist and thus afford the luxury of always finding support in the debt markets to provide liquidity and refinance any upcoming debt maturities as required.
Whilst the future direction of oil prices remains to be seen, the background environment appears set for higher oil prices, especially with OPEC+ seemingly struggling to increase oil supply and thus their shareholders appear set to grab an insanely high 30% dividend yield, if not higher. Even if this does not eventuate, there seems to be minimal risk of oil prices crashing and thus shareholders appear set to at least receive a massive 20% dividend yield given their variable dividend policy, which means that I believe a bullish rating to be appropriate.
Notes: Unless specified otherwise, all figures in this article were taken from Petrobras’ SEC Filings, all calculated figures were performed by the author.
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