Company Trend Analysis - Petrobras: Q4 Growth Marks Return To Positive Territory - MAY 2017

BMI View : Favourable Q4 results illustrate the gradual recovery currently underway at Petrobras. Though the company will face continued headwinds, further deleveraging and operating improvements will boost investor confidence in the company over the coming year.

On March 22, Brazilian national oil company (NOC) Petrobras posted a BRL2.5bn (USD800mn) profit in Q416. This represents the strongest quarterly net gain since Q115 and helped drive a 57.0% reduction in net losses for the year to BRL14.8bn. This was a result of higher operating income from rising cash flows coupled with positive impacts from a stronger domestic currency.

Petrobras' more positive results underline our view regarding the company's gradual turnaround. Though FY16 results remained relatively poor, we believe continued efforts to reduce development costs and boost output will yield further upside momentum over the course of 2017 ( see ' Petrobras: Turning A Corner, But Challenges Remain ', September 23 2016).

Further Improvement Ahead
Petrobras - Net Income (BRLbn)
Source: Petrobras

The company's success in 2017 will largely depend on its ability to reduce its financial leverage. As the most indebted oil company in the world, Petrobras has struggled in recent years to increase investment into upstream builds in the wake of the kick-back scandal. This forced the company to rethink its heavily-state-led growth model and create a more investor-friendly environment for private sector participants ( see ' Reforms Test Upstream Recovery ', November 2 2016).

However, Petrobras will remain the dominant force in the Brazilian hydrocarbons sector, having operated over 80.0% of the domestic market in 2016. We therefore believe continued deleveraging will be needed to send a strong signal to the international market. The NOC needs to project that it has regained control of its finances and is ready to deepen collaboration with the private sector.

Lower Ratio = More Attractive Partner
Petrobras - Net Debt/EBITDA
Source: Petrobras

Furthermore, we believe a reformist drive at the company led by CEO Pedro Parente will boost revenue and income. The alignment of national fuel prices with international benchmarks will increase inflows while eliminating a burdensome expense previously carried by the company. This, combined with rising crude prices, will further repair the NOC's balance sheet this year.

The positive impacts of its progress thus far are beginning to materialise, supporting our optimistic production forecast. Namely, Petrobras announced a USD600mn increase to its capex budget for the year to USD19.9bn, 82.2% of which will be directed upstream. This was a result of falling production costs and better integration of the industry, having increased use of domestic feedstock at refineries which cut import demand.

We believe a spending increase in 2017 is possible given the lower level of debt that is due over the next two years. Specifically, the company has over USD76.0bn in debt maturing between 2017 and 2021, USD20.1bn of which will be due by year-end 2018. This will support efforts to invest upstream, particularly in the ultra-deepwater presalt.

Larger Repayments Further Ahead
Petrobras - Debt Maturity Profile, USDbn
Source: Petrobras

While we maintain an upbeat outlook, we caution that significant challenges remain. Petrobras' development strategy is heavily reliant on an ambitious divestment plan whereby the company hopes to shed USD21.0bn worth of assets between 2017 and 2018. This strategy has already proven challenging as evidenced with its 2016 divestments. These amounted to USD13.6bn, USD1.5bn short of the target, but were frozen by an injunction in November 2016.

The company is undergoing legal proceedings to lift the order and restart negotiations. However, this highlights the challenges associated with the strategy and threatens the NOC's ability to execute its investment plant this year. Moreover, the company's total debt remains a concern at USD118.4bn as of Q416. This will limit the company's access to credit and cap investment in the event of a prolonged legal setback.

Target Remains Ambitious
Petrobras - Total Domestic Liquids Production (mn b/d)
f = forecast. Source: Petrobras company data, BMI

We therefore believe the company will not meet its five-year production target. We forecast domestic oil production will reach 2.53mn b/d by 2021, compared to Petrobras' target of 2.77mn b/d. Our forecast does imply a moderate level of growth, averaging 3.6% y-o-y over the period.