2023-12-12 07:00:00 ET
Summary
- Petrobras has a unique portfolio of assets and it's focused on spending heavily for rapid production growth.
- The company has had substantial governance and balance sheet issues that it's cleaned up.
- The company has the ability to drive substantial shareholder returns, primarily through dividends. Regardless of how it spends its cash, it's a valuable investment.
Petrobras (PBR) is one of the largest national crude oil companies in the world. The company has a market cap of almost $100 billion, but it has a history of numerous problems with the Brazilian government and state influence. As we'll see throughout the article, the company's reorientation to growth and exports will help long-term returns.
The Brazil Problem
Petrobras' problem is the governance with Brazil. Petrobras is majority owned by the federal government of Brazil, which owns more than 50% of the common shares .
Brazil isn't a country with great governance. Among the consequences of this setup was "Operation Car Wash", a small money laundering investigation that led to evidence of a massive corruption throughout the Brazilian government. Petrobras was arguably the largest state-owned company that was a part of this corruption .
The net result to Petrobras was immense. Almost $20 billion in write-downs, billions in bribes, and more than $10 billion in asset write-downs. The net result was a guilty verdict for the CEO of Petrobras that ended up being overturned due to concerns over the trial . Petrobras was also incredibly weak with a massive debt load that it needed to pay down.
Even today the company's ties to the Brazilian state remain. As oil prices went up, rather than receiving pure profits, the company faced massive pressure to lower prices to help other domestic businesses . That pressure led to lower profits. Brazil also, on top of its ownership, pushes more for dividends than share buybacks, and receives massive tax revenue.
All of that together, puts Petrobras in a difficult position. One way around that, exports. It enables the company to bring tax dollars back without local pressures to keep prices low.
Petrobras Overall Goals
Petrobras' overall goals are to focus on production growth with its new pre-salt discoveries along with an integrated high margin portfolio.
Petrobras Investor Presentation
The company is following a similar strategy to what ExxonMobil did with FPSOs in Guyana, and the company's FPSO Almirante Barroso has hit production capacity in <5 months. The company is setting new records for operated production, making it among the largest oil companies in the world from an operated production point of view.
The company is also focused on shareholder returns. Strong dividends, potential share buybacks, and more. We'd like to see the company dramatically ramp up its share buybacks given its high dividends. That could enable the company to have dramatically higher dividends for the long run. However, at the end the Brazilian government wants the dividends.
Still, the company's goals of high margin growth combined with dividends makes it a valuable investment.
Global Warming
For the long run, Petrobras' risk is global warming and the movement away from fossil fuels.
Petrobras Investor Presentation
The company's capital spending plan allocates effectively nothing for low carbon renewable production for Brazil. That's despite the vast majority of the world's population and economies now targeting net-zero in the upcoming 20-30 years. While petroleum will likely never completely disappear, that means demand will drop substantially.
For example, numerous plastics, lubes, etc. remain essential for the worlds continued operations and will likely to continue. On the other hand, a substantial percentage of vehicles will likely be replaced by electric vehicles powered by renewable fuel sources. That powering means that overall crude oil demand will go down substantially. Eventually, Petrobras will need to adapt or get left behind.
Petrobras Investor Presentation
Fortunately, it does have one benefit in the near-term. That benefit is that most oil fields and wells are relatively short duration. The company doesn't lose money if demand drops because it simply needs to spend less dollars on production replacement and growth. As seen above, a substantial percentage of the supply in the market is expected to be new discoveries.
That can easily be cut down. That means that Petrobras' immediate cash flow will likely result in strong profits.
Petrobras 5-Year Plan
The company's 5-year plan involves a massive ramp up in capital spending primarily focused on production growth.
Petrobras Investor Presentation
The company has high barriers for returns and it expects to hit them. It's IRR average for exploration and production is 23%, 14% for refining, transportation, and marketing, and >8% for gas and low carbon energies. Those are high margins for the company's continued investment. It's spending more than $100 billion USD over 5 years one of the highest capital budgets.
The vast majority of that is exploration & production which will average more than $14 billion per year. The benefit though is this isn't sustaining production, the company expects that spending to enable it to grow. The company is getting 400k new barrels / day of growth, which is exciting to see.
Petrobras Shareholder Returns
The company has numerous sources and uses of cash over the next 5 years.
Petrobras Investor Presentation
Counting earn-outs and divestments, the company expects to earn a midpoint of almost $200 billion USD over the next 5-year period. From this, the company plans to invest a staggering $92 billion. Leasing is another $38 billion, and the company's capital spending could increase. The company's capital spending has already ramped up versus its prior 5-year plan.
The company is maintaining the capital to pay down some debt and interest expenditures, but overall its net debt profile is incredibly strong. The company has no substantial risk from its debt positioning. The company's remaining capacity for shareholder returns is $42 billion in dividends and $7-8 billion in potential additional dividends or share buybacks.
For a company worth just under $100 billion, that's roughly 10% in annualized shareholder returns. That might sound low given the risk, but also keep in mind how much is being spent on capital growth. The company expects production to grow from 2.8 million barrels / day to 3.2 million barrels / day or more than 10% over that same time.
That's massive production growth that can help returns. The company is also predicting dropping prices in real terms towards $70 / barrel in 2028. Any improvement there can substantially help shareholder returns.
Valuation / Dividend
At the end of the day, the question becomes what's a fair valuation for the company and what's the long run shareholder return potential.
For the company's dividend, we expect it to grow. The government doesn't seem interested in changing its ownership stake or share repurchases, but it does seem very interested in an aggressive dividend providing direct additional cash flow on top of taxes. That makes sense. Share repurchases only provide indirect rewards without the government selling its stock.
The company has guided to roughly 8-9% annualized dividends at the core over the next 5 years and given what we feel are pessimistic oil prices assumptions, we feel that's very reasonable. We think the government risk here is essentially 0, especially given the company's clean balance sheet.
There is some risk of a new administration coming in that doesn't have the same view, pressuring Petrobras to give up profits for the local populace, a short-term insight. That risk is worth monitoring, but we feel it's low at this time. Still, unexpected politicians have come into power in many places.
From a valuation perspective, many oil companies have a dividend half the current dividend. More so the company's 8-9% base dividend doesn't include balance sheet clean-up, potential additional dividends / share repurchases, growth, or higher oil prices. These are all areas where we feel the company is being cautious based on its guidance.
Using dividends as a core though, we see the company's fair value at roughly double its current market cap. This disconnect versus the company's current valuation helps highlight it as a good investment.
Thesis Risk
The largest risk to our thesis is crude oil prices. As we see above, the company is very profitable at its forecasts of $70-80 / barrel Brent. At more than $80 / barrel, it's obviously insanely profitable. At prices well below that, the company is dramatically less profitable. That will hurt its ability to drive shareholder returns within its goals.
Conclusion
Petrobras has an impressive portfolio of assets. The company has a market cap of almost $100 billion. The company is also entering a major phase of growth with a high barrier for margins. It's planning to spend more than $100 billion over the next 5 years, growing production by the double-digits, while driving strong returns.
The company has had substantial historic risk from Brazil governance. At the same time, the company is still focused on fossil fuel growth, at a time when the global market is changing. The company has cleaned up a lot of the first risk, and it's still working on the second risk. However, overall, we expect the company to generate double-digit shareholder returns.
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Petrobras' 5-Year Plan Highlights The Investment Opportunity