Petrobras: 35% dividend? Still not worth the risk

  • Latest Petrobras Dividend Is Unprecedented, With 35% Dividend Yield
  • Presidential run-off scheduled for October 30 poses huge risks to business as left-wing candidate Lula da Silva maintains his lead
  • If political risk were to coincide with a deep recession, Petrobras would quickly be drained of its free cash flow

Introduction

A glance at its financial statements will tell you that Petrobras (NYSE:) is doing well, producing record levels of free cash flow that are allowing it to distribute profits to shareholders, who have been promised an unprecedented dividend of R$6.73/share for the second quarter, for a dividend yield of 35% (annualised). Despite the potential payout, the upcoming elections in Brazil and the fragile macroeconomic environment pose serious risks to the name. Should political and economic risks coincide – which seems more likely by the day – Petrobras would be drained of its free cash flow and shareholders would be left behind.

Company

Petrobras – the partly state-owned Brazilian oil producer and refiner – has very high quality upstream assets that are proving incredibly profitable in the current macroeconomic environment. Its world-class crude guarantees high prices on the world market, which also makes it more resistant to down cycles. Petrobras enjoys an attractive combination of large reserves and low production costs that make their fields profitable at oil prices as low as $30 a barrel.

Given the government’s majority stake (29%), Petrobras often has to balance political and financial objectives. For example, it is not uncommon for Petrobras to offer discounts on its domestic products to woo politicians. Given their political nature, local refining and marketing activities contribute much less to the company’s bottom line than upstream activities.

Despite political constraints that prevent the company from maximizing profits in its downstream operations, it remains highly profitable, with much of that margin translating into strong free cash flow generation.

finance

Petrobras finances

Source: InvestingPro (figures in USD)

The surge in oil and gas prices we saw in 2Q22 saw the Petrobras report beat the already record 1Q22 numbers. Operating cash flow more than doubled from $10.3 billion to $24.8 billion, a 37% increase from 1H21. In the first half of 2022, shareholders saw free cash flow of $22.5 billion, more than 70% of which was generated in the second quarter alone. Petrobras has also managed to maintain its profit margins above those of other oil producers with similar production levels.

In terms of debt, the company has significantly cleaned up its balance sheet over the last 8 to 10 years. In the second quarter of this year, net debt was $34 billion, up from $53 billion a year ago. Debt to EBITDA is also close to an all-time low, at just 0.5x (on an estimated EBITDA of $65 billion). Given Petrobras’ free cash generation, these debt levels are far from worrying.

This strong financial performance led Petrobras to announce an unprecedented dividend that caught the attention of many investors, including myself.

Dividend

Petrobras announced a dividend of R$6.73/share for its second quarter, or $1.28/share at current rates. On an annualized basis, this translates to approximately $5/share, or a dividend yield of 35%.

Petrobras paid $8.3 billion of its $12.8 billion in available cash for the second quarter. A $5/share dividend for FY22 would cost the oil producer ∼$32.2B – given free cash flow of $22.5B for 1H alone, it should be covered easily.

For those who bought before the ex-dividend date, congratulations. For those who bought after or are looking to buy, I suggest looking carefully into the future – it doesn’t look too bright.

Risks

Presidential race

On October 2, more than half of Brazilians voted in the first round of their presidential elections. Incumbent President Jair Bolsonaro – a right-wing populist in power since 2019 – did better than expected, garnering 43% of the vote. His main opponent, former left-wing president Luiz Inácio Lula da Silva (commonly known as Lula), obtained 48%. All the polls indicated that Lula would be better off. The two will go to a second round of elections on October 30, with Lula and his Workers’ Party still favored.

in Brazil is currently at a high number and the conditions are becoming more and more difficult. The company is unlikely to hand out billions in dividends while the people of Brazil suffer from shortages. Regardless of who wins, some degree of political pressure on Petrobras is a given. For investors, this represents a significant risk.

The government-linked oil producer has already been called by both sides. During his election campaign, Bolsonaro often fired shots at Petrobras, saying the company was systematically working against the Brazilian population and calling the company’s profits “absurd”. Although the president has temporarily chosen to refrain from directly intervening in Petrobras operations, it is hard to imagine a scenario in which – if he wins – he would not act against Petrobras in one way or another. another (for example, exceptional tax).

A potential leftist government could rock the boat even more. Given his comments in recent weeks, it is almost certain that Lula will pressure Petrobras to lower gasoline and diesel prices in Brazil, further reducing the profitability of Petrobras’ downstream business. As Election Day approaches, he increasingly calls for a separation of local oil prices from the global market. In Lula’s words, “I can’t make an American stockholder richer and a local housewife poorer who will pay more for a bag of beans because gas prices have gone up.” The leftist candidate also mentioned plans to expand Petrobras’ refining capacity, which could impose higher costs on Petrobras. Although it is still too early to determine the extent to which future government policies may impact Petrobras’ financial performance, there is only downside risk.

Although not as severe, the current macroeconomic environment is also a risk to consider. I think the downturn is already properly priced in, but there is room for dividend and earnings losses if the market anticipates a worse-than-expected global recession. Not only that, but a severe downturn could also magnify the risks of government intervention, as politicians would most likely protect the Brazilian population at the expense of Petrobras shareholders.

Conclusion

*Historical multiples – P/LTM FCF, P/E. Source: InvestingPro*

Historical PBR multiples

Historical PBR multiples

Trading at 2.7x P/LTM FCF and 3.2x P/NTM EPS, Petrobras is relatively cheap. However, this does not mean that the share price will go up. Concern over the upcoming election is clearly impacting the stock, and rightly so. Only a few days before the second round, the former left-wing president Lula seems to be in the lead. Given his comments on price caps and forced refining capacity increases, a victory for the Workers’ Party would be a blow to Petrobras. That said, a Bolsonaro win wouldn’t be advantageous either. Despite the low multiples and high dividend yield, the political uncertainty combined with a gloomy macroeconomic outlook makes the downside risk significantly greater than the upside risk. Now is not the right time to buy Petrobras.

Disclosure: The author does not currently hold any position with Petróleo Brasileiro SA – Petrobras. This article is written for informational purposes only. It does not constitute a solicitation, offer, advice, advice or investment recommendation.

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About Myra R.

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