A Look At Petrobras’ Capital Structure

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Petroleo Brasileiro

The commodity markets around the world have been in the doldrums since mid-2014. The oil glut, caused by excess supply and declining demand, wrecked the expansion plans of a majority of oil and gas companies and deteriorated their profitability severely. So much so that the cash flows of these companies have dried up, forcing them to raise additional debt in order to pay out dividends and repay their existing debt. For instance, Petroleo Brasileiro Petrobras‘ (NYSE:PBR) ability to generate cash flows has gone down significantly, while its leverage has gone up considerably over the last few quarters. Hence, in this note, we aim to discuss how the Brazilian integrated company’s capital structure has become skewed in the last two years and how it plans to correct this over the next few years. You can read our previous articles in this series where we analyzed Petrobras’ productioncost reduction and capital allocation strategies.

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Source: Petrobras The Way Forward, October 2016

Skewed Capital Structure

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In contrast to its counterparts, Petrobras has not raised a large amount of debt to meet its capital spending needs in the last two years. This is primarily because of the fact that the company’s balance sheet already has a huge amount of debt and the company may not be in a position to raise additional debt at attractive rates. Furthermore, despite the declining cash flows from operations, the energy company has managed to reduce its long term obligations in the last few quarters as opposed to its peers, who have increased their leverage in the same duration.

However, on the flip side, due to its diminishing profitability, Petrobras has seen a steep decline in its shareholders’ equity. This has resulted in a sudden rise in the company’s debt-to-total capital ratio, which is used as a measure to determine the leverage of a company. Petrobras’ leverage has increased from around 40% in 2013 to more than 60% in 2015.

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In addition to this, Petrobras’ Net Debt to EBITDA ratio, which shows the number of years that it requires to repay its long term debt (excluding cash and cash equivalents) at the current rate of profits, has also gone up drastically. The company’s Net Debt to EBITDA ratio has increased from 3x in 2013 to 3.8x in 2015 and is likely to reach an all time high of 5.6x in 2016, based on our estimates.

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Corrective Measures

Petrobras’ management is conscious about the rising concern of investors regarding its increased exposure to debt. As a result, the company aims to bring down its leverage to less than 40% over the next two years, and to less than 35% by 2020, assuming that the commodity prices recover gradually. Similarly for the Net Debt to EBITDA ratio, the company plans to reduce this ratio to 2013 levels of 3x by 2018 and further to less than 2.5x by the end of this decade.

PBR-Q&A-debt

Our Take

Petrobras is taking corrective steps to improve its capital structure by bringing down its debt level. However, the effectiveness of this plan will be dependent on the recovery in the commodity markets and the company’s execution skills. Based on our estimates, we believe that Petrobras will be able to improve its leverage over the next three years, subject to a steady rebound in commodity prices over the next few years.

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