The Problems With Petroleo Brasileiro SA Petrobras (ADR) (NYSE:PBR): Would They Just Go Away?

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Petroleo Brasileiro SA Petrobras (ADR) (NYSE:PBR), the largest energy firm in Brazil, has been reporting production growth, but faces headwinds from weak commodity pricing and the recent money laundering scandal. Added to this, the company has a huge debt, which makes the stock weak. However, given the size of the firm and its investment base, the company has the potential to bounce back, if it can deal with some problems in the coming year.

Depressed Financial Results

Petrobras continues to suffer a year-over-year decline in commodity pricing, despite having increased production. For its 2Q2015, the company reported a year-over-year decline of 62% in revenues. This is mainly due to lower commodity pricing, which has affected the whole industry in general. This is one of the major problems for the company, one over which PBR has no control off. However, much like other big players in the industry, PBR has started exercising cost cutting.

The company recently announced that it would be slashing its capital expenditure for the current year to $25 billion. The real change, however, would be visible in FY2016, when the company expects capital expenditure to be around $19 billion, instead of $27 billion. This is one step that the company has taken far too long to implement and does not reflect well on the management. Analysts expect that the decrease in expenditure would help lower some of the debt of the company.

Money Laundering and Debt

The biggest problem for the company, at the moment, is its involvement in the multi-billion dollar money laundering case. Not only has the case defamed the Petrobras name, it has also made it difficult for PBR to find creditors for future endeavors. This tends to create a big problem for ongoing operations by the company, given that a large part of its capital is composed of debts.

Currently, the threat has been delayed, with the help of China Development Bank, which has loaned the company a total of $5 billion. Furthermore, two other banks from China have also agreed to loan PBR another $5 billion. This buys the company enough time to get itself into a better position for growth. In its 3Q2015 report, PBR revealed that its net-to-debt capitalization ratio is 58%. Added to this, the new loans from China would further decrease this ratio, meaning that the company is losing leverage over its creditors.

The Positive Side

Finally, PBR’s international operations are also severely affected by lower commodity prices. As such, adverse fluctuations in the foreign exchange rates tend to cost the company dearly. However, the majority of its operations are based in Latin America and the company caters to the majority of Brazil’s crude oil needs. This tends to create a unique advantage for Petrobras, since a change in the Brazilian economy or energy legislation would help the company improve its margins.

Production Capacity

Petrobras has been concentrating most of its resources on increasing oil production. This has also led to the discovery of oil in the Pitu area, in the Potiguar basin. PBR has a 40% stake in the project and expects to capitalize on it. However, the greatest increase in production has been experienced by PBR’s international projects, 2.8%. Furthermore, production from the pre-salt region declined by 1.6%, while that from Brazilian sources was up by 1.6%.

Conclusion

Currently, Petrobras finds itself in a very tough position. The company has a large debt, which is constantly increasing. Added to this, the new loans from China have further limited PBR’s credit facility and added additional burden on the balance sheet. However, this move was necessary for continued operations by the company. One of the major problems with Petrobras is that it continues to increase its production capacity, despite depressed conditions of the market, mainly due to oversupply. Unless commodity pricing in the international markets improve, the investors have little to look forward to.

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