Petrobras: They're Panicking Again

I just wanted to share a quick note regarding last week’s sell-off in Petrobras, as my thoughts have deepened over the weekend. My initial reaction was mild frustration or indifference, as the shares have faced regular shake-outs like this over my three year holding period- no big deal.

But what Friday’s correction (based on a lack of special dividends for Q4) really shows is how far the narrative has come in recent years. My initial PBR purchase was in response to the removal of the CEO and his replacement with a military man and Bolso ally, with no energy experience. This was taken as a sign dividends would soon cease and and the company would become a re-election slush vehicle, through price caps and spending programs. Asset confiscation was certainly considered possible, but the shares were under 2x earnings and seemed a promising investment.

Obviously none of the above happened to any meaningful degree, despite multiple CEO changes since. Expectations were just so low that simply continuing the dividend was enought to march the shares higher.

The next major fear was all-out asset theft and nationalisation as Lula returned to the presidency. The price slumped again in anticipation. One prominent Brazilian investor on Twitter poetically likened foreigners buying PBR to the gringos who hit the town in Copacabana and wake up in an alley with a sore butt, minus their wallet.

The general feeling completely lost sight of the fact that asset seizure by a government that also wants to deal with foreigner investors, attract capital and access international bond markets is an extreme action. Possible, but not as likely as the markets feared.

At the time I wrote a similar note entitled Pricing Armageddon with a Muddle Through Likely predicting a wobbly march forward and the shares have done well since. Essentially, Lula just had to not make any obvious moves to steal the company to beat expectations and even better was realised due to excellent dividends being paid over the period.

All this is to highlight how far the bear case has shifted. State appropriation hasn’t been mentioned as a realistic possibility in some time and the “worst case” appears to have shifted to a mix of dividend cuts, drastic pivot to renewables and economic-supporting spending programs. Some bears have laughably tried to claim this missed Q4 special dividend vindicates their bearish posture from 12-24 months ago.

All else being equal, I anticipate the share price will recover fairly quickly. Management has made it crystal clear that the funds available for special dividend payments are a seperate pool and cannot simply flow into extra capex. It is possible there is a rift on the board over this, but for now the policy is clear. My understanding of Jean Paul Prates is a straight-talker who follows through on his commitments.

In the meantime, owners will have to slum it on PBR’s regular dividends of around $2 per share (a 13.5% yield). But the main reason I expect a swift recovery is the company made $24b in profit last year and trades at a <4 P/E. It’s still far too cheap.

This is why the narrative arc is so important and I believe we are only half-way along. As time passes, production grows and generous dividends continue, the perception should continue slowly shifting until eventually the market views the company as simply one of the world’s major energy companies that happens to be located in Brazil.

This could look like an energy bull market where Exxon trades for 12x strong earnings and PBR at 9-10x. This would obviously be time to consider an exit, but there is a lot of water to flow under the bridge before then. In the interim, I wouldn’t be surprised to see special dividends resumed or even caught up some time in 2024.

Others have written about the situation in more detail than this high level view and I encourage anyone unfamiliar to read The Modern Investing Newsletter’s piece to get extra perspective on the situation and earnings.

I apologise for taking so long between posts. We have moved from Auckland back to Brisbane to start the year, so time and the motivation to write has been low. I promise to push my 2023 Portfolio Review out the door in the next week or so.

Best,

Guy

As always, this isn’t investment advice. Please do your own due diligence and seek professional advice if you’re unsure about your finances.