Brazil's state-owned oil giant Petrobras (NYSE: PBR) is one of the country's brightest economic gems and most embarrassing political black eyes. The tug-of-war being waged between these identities has been playing out in real-time in the last several years.
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On one hand, management's turnaround plan to reduce debt and focus on core operational areas showed enough progress to lift shares 137% in 2016. Impressive growth in Brazil's offshore pre-salt formations have also added to the optimism for Petrobras. On the other hand, the country is mired in its worst economic recession ever, while the political scandal that featured Petrobras and led to the impeachment of a president just doesn't seem to be going away.
While Petrobras bulls are certainly aware of the negative clouds hanging over the company -- shares have slid 23% year-to-date -- they may prove too powerful to overcome anytime soon.
Are these obstacles being properly accounted for?
The fact that Petrobras is a state-owned oil company means it has slightly different influences and priorities than other oil majors. It faces enormous pressure to create jobs thanks to "local content" requirements set by the Brazilian government, which stipulate how much local goods and services must be purchased for any given onshore or offshore project.
Rules requiring 55% of offshore platform and subsea equipment to come from Brazil dramatically reduced the competitiveness and willingness of international companies to bid on development projects. These have been dramatically reduced going forward, to just 25% and 40%, respectively, but will still stifle competition and increase project costs across all six categories bearing local content requirements.
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Petrobras also had to spend enormous sums of money to build oil transportation and refining infrastructure in Brazil over the last two decades. A lack of outside investment partly due to local content requirements and partly due to rules stipulating that the company had to be the operator and primary owner of any joint venture within Brazil didn't help. These realities have led to decisions that weren't always best for the business and unnecessarily high costs.
That helps to explain how Petrobras racked up its astounding amount of debt, which peaked at $165 billion in the third quarter of 2015 using the exchange rate at the time. The good news is that assets sales and new multi-billion partnerships dropped the debt to $109 billion at the end of the first quarter of 2017. The bad news is, well, it had $109 billion in debt at the end of the first quarter of 2017.
That's... ridiculously more than any other major oil company. In fact, no other major oil company ended 2016 with more than $58 billion in debt (BP), while Petrobras had more than twice that level at the end of December. Equally impressive, it racked up the majority of that since the end of 2009.
By many other metrics, Petrobras is on equal or better footing compared to peers such as BP, ExxonMobil, and Total. It has among the leading cash positions and cannot be beaten on operating cash flow. But its enormous debt has restrained its market valuation to less than half of its peers.
What does it mean for investors?
So, although the company is, in fact, making progress and wants to reduce its debt by many billions more, there's a lot of ground to make up. It will be impossible to do so with asset sales alone, which means Petrobras could be fighting for a higher market cap and stock price well into the 2020's.
Couple that with fresh concerns over Brazil's political scandal, which now involves another sitting president (the one immediately before was impeached), and it leaves investors with the reality that both the near-and-medium-term potential for Petrobras are bogged down in uncertainty. These obstacles are what the bulls may be missing.
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