Petróleo Brasileiro S.A. (NYSE: PBR), or Petrobras, could be the best oil and gas investment in the world. The reason it is not is because of its capital structure inverting common shareholders’ interests, compared to most giant oil companies that investors get involved in. After a huge recovery from its lows, Fitch Ratings has a big warning for investors.
24/7 Wall St. sees this as just one more effort aimed at crushing shareholders in order to be a state-dominated (or state-run) company. The potential consequences for the common stockholder — severe!
Fitch warns that the Brazilian government’s decision to assign the production of the excess volume of the transfer of right areas to Petrobras will further pressure the company’s cash flow generation ability. Further, Fitch warns that this move will weaken the company’s stand-alone credit quality.
Fitch went on to say that Brazil’s decision calls for a BRL2 billion ($909 million) bonus payment to the government during 2014 and the anticipation of BRL13 billion ($5.9 billion) of profits to the government between 2015 and 2018, significantly before any oil is produced from the assigned areas.
In short, at least from our view of what this will feel like from an investor point of view, it is almost the same as if Brazil is taxing Petrobras on profits that have not yet been made. Will they look for more taxes when the profits are actually made or per barrel concessions when the oil is drilled down the road?
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Fitch went on to say:
These payments will put additional burden on Petrobras’ already negative free cash flow resulting from its aggressive capex program. These payments, coupled with the expected downstream losses for this year and moderate production growth during 2014, would negatively impact the company’s internal cash flow generation and increase reliance on borrowings. Considering Fitch’s price deck, Fitch expected that at the beginning of this year Petrobras’ borrowing needs would be around $15 billion, on average, over the medium term. These recent developments could increase the company’s needs for external funding beyond this estimate.
What this looks like is that (on top of having inverted in a capital structure) Petrobras may have to do more capital raising to make less money. That is not good for shareholders.
Fitch went on to warn:
Factors that could result in a negative action on Petrobras’ ratings, independent of a sovereign downgrade, include the perception of a lower linkage between Petrobras and the government, together with a sustained weakening of the stand-alone credit metrics. Qualitative factors that could pressure Petrobras’ ratings include a sustained increase in leverage to a total debt/EBITDA ratio of more than 5.0x. Also, lack of capital market access to fund negative FCF would be detrimental, as well as failure to increase production over the medium term.
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The good news is that Petrobras shares were down only by 0.6% at $14.70 on the heels of the news. The common shares in New York trading have also bounced close to 50% from the lows seen in mid-March (imagine seeing a move like that in other oil companies!). Still, shares hit a post-recovery high of $15.98 on June 24, 2014. That means that the stock was down 8% from its high in just three trading sessions. Imagine what that would do to the Dow Jones Industrial Average if that drop was seen in Exxon and Chevron (hint: it wouldn’t be pretty!).
If you want some additional coverage and views on this story, Reuters has two pieces worth reviewing. The first says that the offshore oil rights may cost 50% more than expected. Ouch, 50%? The second says that Petrobras board members are speaking out against this government action.
We noticed that short sellers have still lightened up on betting against Petrobras in its most recent short interest period. How long will that last if the company will have to beg the markets for more and more money that doesn’t even go to help the company other than to pay even more to the Brazilian government?
Again, Petrobras has an opportunity in time to be the best oil investment in the world. There is just no way that will be the case under a regime that literally puts anyone and everyone in line ahead of the common shareholder in the capital structure.
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As a reminder, this effort is still a work in action and not all of the end results are yet set in stone for the years ahead. That being said, the Brazilian government is still making sure that Petrobras is being forced into operating as a social company under the rule of government rather than a company that would attract most investors for its ability to generate profits.
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