Petrobras

The lure of the dividend

So I was a bit of a Petrobras (PBR) hater. I have traded in and out and collected some nice dividends this year, but never with much conviction. I thought Lula would find a way to bleed the company. And it is hardly a contrarian pick as most of FinTwit seems to own the stock. But as the price kept cratering and especially the A shares trade at an absurd 2x forward earnings right now with a double digit dividend yield, greed kicked in and I decided to have a serious look at the stock.

So I did a bit of digging on what the political risk really is. And it isn’t nearly as bad as the headlines would suggest. For starters, Lula has to deal with a pretty conservative senate/house. So his political capital will be limited. And since operation car wash a lot of new legislation has been introduced that greatly limits the damage Lula can do: 

• The government cannot just Willy Nilly force price caps without compensation on Petrobras (source)

• No one who has been in a political party in the last 3 years can join the company (source)

• Much harder to force bad contracts/contractors on the firm (source)

• Government can no longer force capital expenditures on Petrobras (source)

In my view, the most likely outcome here is that there will be pressure on Petrobras to invest in renewables. Repsol and the European oil majors are a good model here. This means higher capital expenditures that generate an incremental 5-10% ROIC. And lower dividends. So not great, but not terrible either given how cheap the stock is.

What this means in practice is that capital expenditures going forward could be 30-50% higher than depreciation. Although it might take a year or two before this starts happening, which would be good for PBR shareholders. Luckily Petrobras is quite profitable and has significantly higher margins than Repsol. So what this means in practice is that at $80 Brent Petrobras generates about $100 billion of revenue, $55 billion of EBITDA and FCF of about $25 billion. On a ~$60 billion market cap.

I don’t think it is likely that Lula’s people will cut the dividend that much, since with a conservative senate he will need all the income he can get. And he will be limited in shareholder unfriendly legislation. Debt is quite modest now at 1x EBIT. So a 50% dividend payout of free cash flow would imply a $12 billion dividend, assuming withholding tax is increased to 25%, and that is still a yield of 15% for the A shares. 

A more optimistic scenario of a 65% payout ratio and withholding taxes staying at 0% would imply a 25% dividend yield. And remember this already includes a $6-7 billion increase in annual capital expenditures. 

Even if the payout ratio is only 25%, that is still more than a ~10% dividend yield here. And would mean a 75% cut in dividends from 2022. And it will take some time before Lula is able to put his people in charge. The current CEO’s term ends in April 2023. If the 100% payout is maintained for another 4-6 months, that means probably another $1-2/share in dividends coming soon. 

For an oil company, the risk seems pretty low here. I don’t think Petrobras deserves to trade at a 50-70% discount to Repsol and the Euro oil majors. Say a 30% discount to Repsol would be fair, and another $2-4 in dividends in the next 2 years and your upside here is 75%. On pretty modest assumptions.

As for the price of oil, Biden has been selling 1 million barrels/day from the SPR. Which is now at about 400 million barrels. So he can keep that up for one more year, and then he has to start buying again. And despite the extra 1 million barrels of supply, Brent is still above $80. 

Longer term, Russian oil output will likely decline. In fact Russia has already announced a cut of 500k barrels next year. And American shale has matured/consolidated. China will open up again within the next 2 years. So not a bad time to invest in an oil company at ~2x earnings. I do not have a strong opinion on where oil prices will go, but the supply/demand set up seems somewhat bullish. 

So I have taken a sizable position in Petrobras A shares at an average price of $9/share. I don’t think the lack of voting rights matters that much when you get the same dividend. In fact dividends cannot be stripped completely for preferred shares, under Brazilian law, payout must be a minimum of 25% of adjusted net income. So at $80 Brent and a share price of $8.7, at least a 10% yield.

Of course I may sell at any time, and do your own research before buying.