Why Ratings Agencies Would Be Worried About Petrobras

Seemingly these recent problems with the company began when Dilma Rousseff was reelected as Brazil’s president in late October. Petrobras shares fell as much as 16.5% that day in reaction to the election results, and longer-term this company has been under political pressure as well.

Granted, there are other inherent risks when investing in Brazil whether or not the issue is electing socialist leaders. Petrobras also delayed its formal earnings report for the third quarter.

In late November, the company announced that it had received a subpoena from the SEC. Petrobras’ statement was brief and lacked any details, including whether or not the SEC subpoena was related to the corruption charges that had been leveled against a former employee and another person, alleging that the two skimmed funds from company construction contracts to pay kickbacks to Brazilian politicians.

Members of Brazil’s ruling political party, the Workers Party or PT, were charged with having received payments of 3% of the value of construction contracts from a number of companies in exchange for contracts. The PT and Brazilian’s recently re-elected President Dilma Rousseff denied the charges. Rousseff was the minister of energy from 2003 to 2005.

At the time of the subpoena, the shares were helped briefly by an upgrade by Citigroup. Analyst Pedro Medeiros upgraded the shares to a Buy rating, with a $13 price target, writing that Petrobras has gotten too cheap after selling off more than 20% in the past year, especially as he sees earnings per share (EPS) growth in 2015 and 2016 leading to a 23% recovery for the stock.

In the most recent settlement date for the short interest, Petrobras saw its short interest fall to 88.8 million shares, with 2.19 days to cover. The previous short interest level for Petrobras was 93.6 million. These are the two highest short interest numbers that have been recorded in the past 52-weeks and reflect the recent investor sentiment.

24/7 Wall St. has been critical of Petrobras for years now. The reason for that criticism is that this company is not allowed to operate in the same manner as traditional companies. It is a state-run entity, and its common shareholders and ADS holders have a structure that puts them even lower down the line than traditional companies. Petrobras has prices dictated to it that it must pay to get the oil out of the ground and for which it gets to sell the oil. And its governance is effectively dominated by the government and by a large ownership stake by its unions that come before shareholders, and there is a large preferred stake to deal with as well that is uncommon versus other Western oil giants.

Fitch noted a few main points in its report for Petrobras’ credit:

• Recent allegations of corruption scandals in its contracting practices have the potential to affect its credit quality to the extent that it slows production growth
• The credit quality is sensitive to its production growth to bolster cash flow generation and reduce leverage while access to debt capital markets is also critical in the medium term
• Capex is rigid in the short term and will pressure Petrobras’ ratings if cash flow does not improve
• Credit quality could deteriorate if it can’t adjust prices to reflect movement in the foreign exchange rate and/or international crude prices

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Shares of Petrobras were down over 2% at $8.90 in the last two hours of trading. The shares have fallen 57% since its 52-week high in early September when there was some hope that the election results might not be so much against it. The stock has a consensus analyst price target of $15.64 and a 52-week trading range of $8.80 to $20.94. It has a market cap of almost $59 billion.