Here Are The Factors That Will Drive Petrobras’ Value In The Near Term

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PBR: Petroleo Brasileiro logo
PBR
Petroleo Brasileiro

Petrobras‘ (NYSE:PBR) stock price has dropped more than 25% since the beginning of the year amidst the volatility in the commodity markets. Despite posting a strong improvement in its March quarter performance, the Brazilian company’s stock has plunged drastically, as the rally in oil prices that began post the OPEC deal has come to an end. To add to this, a corruption investigation has been ordered on the company’s former CEO, Aldemir Bendine, with charges of asking and receiving a bribe of 3 million Reais from the Odebrecht construction firm. This probe also suggests that corruption could have continued within the company. This has led to weakening of investor confidence in the company, resulting in a severe sell off of the company’s stock.

However, the integrated energy company remains optimistic about the recovery in commodity prices, and expects to meet its production as well as cost reduction targets as planned. Further, the company is leveraging every opportunity to bring down its debt obligations to improve its balance sheet and credit rating. In this article, we discuss the company’s targets for 2017 and beyond, and how it plans to execute them. We have revised the company’s model in accordance with the changed reporting structure. We currently have a price target of $9.60 per share for Petrobras, which is 19% higher than its market price.

See Our Complete Analysis For Petrobras Here

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PBR-Q&A-stance-1

Source: Google Finance; US Energy Information Administration (EIA)

Production Targets

According to its Business Management Plan for 2017-2021, Petrobras expects its overall hydrocarbon production to be around 2.62 million barrels of oil equivalent per day (boed) in 2017, and plans to grow it to 3.41 million boed by 2021. The majority of this will be driven by the company’s domestic operations. Beyond 2017, it plans to expand its domestic liquids production at an annual rate of 7.5%, and its natural gas output at a rate of 6% annually over the next four years. This translates into a compounded annual growth rate (CAGR) of around 7% on the total hydrocarbon production over the remaining years of this decade. While such a big jump in the oil and gas output could be a huge upside for any company in a strong price environment, it could be detrimental for Petrobras if the commodity prices do not recover as quickly as the company is anticipating.PBR-Q&A-prod-2

In order to meet its aggressive growth plans, Petrobras aims to spend $74.5 billion in capital expenditure over the next 3-4 years. Of this, $17 billion is likely to be spent in 2017, with more than 80% attributed to exploration and production activities. This target is lower than the company’s previous expectation of $20 billion. Given that the commodity markets are still uncertain, restricted yet focused capital investment will allow the company to improve its margins and enhance shareholder returns.

To finance these expansion goals, Petrobras intends to enter into strategic partnerships with relevant third parties, within and outside Brazil. In addition, the integrated company will continue to divest its non-core and low-margin assets over the next few years to fund its capital spending needs. The energy company expects to raise around $21 billion through its strategic partnerships and asset sales in 2017 and 2018, as opposed to its previous guidance of $19.5 billion. These proceeds will not only allow the company to meet its capital spending needs, but will enable it to do so without increasing its debt obligations.

PBR-Q&A-capex-2017

Cost Reduction Measures

With an aim to improve its profitability, Petrobras has managed to reduce its manageable costs significantly over the last couple of years. Since the commodity markets remain unpredictable, the Rio de Janeiro-based company will continue to bring down its lifting costs from around $11 per boe in 2016 to $9.60 per boe in the forthcoming years by increasing its participation in pre-salt plays and managing its drilling rig idleness. In fact, the company has made strong headway in this direction, and has reduced its manageable costs to $18 billion in the 1Q’17, 18% lower compared to the same quarter of last year.

Apart from streamlining its upstream costs, Petrobras also has plans to reduce its refining costs, which form a significant part of the company’s overall operating costs. The energy company aims to integrate the common and interdependent activities among its refineries, and optimize the consumption of power, catalyzers, and chemicals to bring down its refining costs from roughly $500 per unit of equivalent distillation capacity (UEDC) in 2014 to under $300 per UEDC over the remaining years of this decade.

Petrobras’ Cost Reduction Initiatives

PBR-Q&A-cost-1

Reducing Leverage

Petrobras is known to be the world’s most indebted oil company, with around $118 billion of long-term debt on its books at the end of 2016. However, the company pared down almost $3 billion of its debt in the March quarter, bringing down its obligations to $115 billion. Further, the company announced the issue of $4 billion worth of debt in the international markets last month((Petrobras Issues $4 billion In Debt In International Markets, 23rd May 2017, The Wall Street Journal)), aimed at repaying a portion of the $30 billion of debt coming due in 2017 and 2018 (interest plus principal). This deal has enabled the company to refinance its long term debt at the lowest average interest rate since 2013, bringing down its cost of debt notably.

While there is still a long way to go before Petrobras can boast of an optimal balance sheet, it is surely making progress towards achieving its goal of reducing its leverage and Net Debt to EBITDA ratio. 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. In terms of the Net Debt to EBITDA ratio, the company expects to reduce this ratio to 2.5x by 2018, much lower compared to its earlier target of 3x in the same timeframe. In fact, Petrobras has already managed to bring down this ratio to 3.2x in the first quarter of 2017, indicating that the company is working well towards achieving its objectives.

Petrobras’ Net- Debt-to-EBITDA RatioPBR-Q&A-debt-1

Thus, we conclude that despite the ongoing turbulence in the commodity markets and the geo-political risks in the Brazilian economy, Petrobras has chalked out a solid strategy to weather the current commodity slump, and is progressing well towards achieving its targets. However, the pace of recovery in commodity prices will continue to play a crucial role in the sustainable improvement in Petrobras’ value.

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