Avoid Petrobras Shares. Here's why.

By Markets Fool.com

Despite the tremendous fall in the price of Petrobras(NYSE:PBR) more than 50% since Dilma`s re-election in October 24th 2014 investors should still avoid investing in its shares. There are 3 main reasons why the stock prices could fall even further:

Continue Reading Below

1- Corporate Governance

Petrobras primary focus is on the interests of the main shareholder Brazil`s government and it does not respect the minority shareholders. This is a situation that doesnt seem to be changing anytime soon. Since 2002, the company has been investing a huge amount of money in the government strategy. Instead of paying dividends to all shareholders, its return oninvestment came through votes during the presidential elections.. Most professionals were replaced by politics and this is one of the causes of the corruption scandal.

As a result of the management blackout, the auditors of PriceWaterHouseCoopersrefused to sign the Financial Statements without identifying the losses from the corruption of inflated assets. Therefore, the company was not able to present audited financial statements of the 3rd quarter of 2014, until now. During the last conference call, former CEO Graca Foster declared preliminary estimates that its assets had been overvalued by BRL 88 Billion (US $31 Billion). Just to get an idea of how much this means, the current market value of Petrobras is BRL 122 Billion (US $42 Billion). After the conference call, the entire team at the top was gone and replaced by others, even closer to the Government. This disappointed most of the investors, ruining the possibility of any improvement in Corporate Governance in a short term.

Petrobras was the most valuable brand in Latin America in 2012. In 2014, the company was not among Top 10. Source:Millward Brown Photo: Petrobras

Continue Reading Below

2- Oil Prices and High Production Costs

Current oil prices could bring problems to the business model and the internal price protection is not a sustainable strategy. While Petrobras privileges political interests, the company will not be able to explore its full potential and focus in competitiveness to face adverse macro conditions.

Oil prices are down more than 50% over the past eight months, from US $107 to US $50, and seems not to be rising anytime soon. New Petrobras deepest drilling area - called Pre Salt - involves extraction costs of US $45 per barrel and current sale prices could derail some wells, which means a high risk for the future of the company. Petrobras pricing power, due to governmental influence, is a source of stress to the management. The popularity of Dilma is at the lowest level in 12 years, influenced to rising in oil taxes and scandals. It caused a recent truck drivers blockade of several railways claiming for reduction in Oil prices. Instead of reducing taxes, it could spill into Petrobras margins, again.


3- Huge debt and Rating Downgrade

After discovering new areas in Pre Salt, Petrobras developed a huge investment plan to explore the new areas. Although the new opportunities sounded like good news, in order to afford the investment plan, the company increased the debt aggressively, and now it is a source of trouble. What appeared as an awesome opportunity to boost the company has actually been destroying its value for the shareholders.


Petrobras' net debt in the 3rd quarter of 2014, according to the non audited numbers, was BRL 261 Billion (US $91 Billion), which represents a high level of indebtness close to 4.6x EBITDA.


Despite a huge effort from the Finance Minister Joaquim Levy a bad agency evaluation could not be avoided. All these problems caused a Rating downgrade of Moody`s, from Baa3 (Investment Grade) to Ba2 (Speculative Investment). About that, Dilma declared: It shows lack of knowledge about what's going on at Petrobras. I have no doubt that it's a company highly capable of recovering from this, without major consequences. Dilma is right, there is a lack of knowledge about what is going on at Petrobras, mainly about the financial numbers.

Poor corporate governance, current oil prices and huge debt are pushing the management to make decisions under pressure. And it might not have enough time to choose the best way.

Petrobras decided to sell some assets in order to reduce its debt. Mistrust from the market and the sense of urgency will certainly induce the company to make bad deals destroying even more its value. And that's why I believe now is still not the time to buy Petrobas.

The article Avoid Petrobras Shares. Here's why. originally appeared on Fool.com.

Paulo Marchetti has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.