Petróleo Brasileiro S.A.

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

Petróleo Brasileiro S.A., or Petrobras, is a large state-controlled Brazilian multinational corporation involved in exploration, production, refining, marketing, and transportation of oil and gas.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Petrobras operates across the entire value chain of the oil and gas industry, with key activities including:

  • Exploration and Production: Petrobras is involved in both onshore and offshore exploration and production. Notably, Brazil has vast offshore reserves in the pre-salt area, which are a significant focus for the company. The pre-salt reserves are deepwater oil and gas deposits located beneath thick layers of salt, making extraction complex and technologically advanced.
  • Refining, Transportation, and Marketing: This segment handles the refining of crude oil into various petroleum products, including gasoline, diesel, and jet fuel. It also involves transporting these products to market and distributing them to consumers. Petrobras also deals with trading and marketing of crude oil and natural gas
  • Gas and Power: Petrobras also has interests in natural gas transport, power generation, as well as petrochemicals and biofuels.
  • Strategic Focus: Petrobras has been focusing on its core business of exploration and production with a greater focus on the pre-salt regions and has been divesting assets that do not meet its long term plan. They have also been focusing on the highest paying operations.

Moat Analysis

Petrobras’s economic moat is complex, comprised of a mixture of structural advantages and vulnerabilities. Here’s a breakdown and a moat rating of 3 out of 5:

Petrobras is not a monopoly. It has to compete with other companies.

  • Intangible Assets (Narrow Moat Element): Petrobras’s strong brand recognition in Brazil and its technical know-how in deepwater and pre-salt exploration give it a degree of intangible value. It is the go-to oil supplier in the country, which gives it a competitive edge over any other potential entrants to Brazil.
    • However, brand loyalty may be limited in a commodity business like oil, because buyers tend to focus on price and quality, which limits pricing power.
  • Cost Advantages (Narrow Moat Element): Petrobras benefits from proprietary knowledge of its domestic oil reserves and infrastructure built up over decades. The low-cost, high quality pre-salt oil that is extracted is a cost advantage. This, however, is partially offset by high extraction costs, and also has to be weighed against the higher costs of operating in Brazil versus other oil-producing countries.
  • Switching Costs (Potential Moat Element): Refineries and end-product customers have some level of dependence on Petrobras and will have high costs of switching providers. This is especially true in the domestic market where a lot of downstream operations are connected to Petrobras. However, these switching costs aren’t as powerful in the international market because large customers can import the same products from other suppliers.

Moat Rating: 3/5 (Narrow to Moderate). Petrobras possesses some elements of a moat through brand, specialized skills, and cost advantages in its Brazilian operations. However, these are partially offset by regulatory influences, limited pricing power, and the commodity nature of the business. The company doesn’t have a wide moat, as most of these factors are replicable and somewhat common, and its earnings remain dependent on the commodity price of oil and gas.

Risks to the Moat and Business Resilience

Petrobras faces legitimate risks that could erode the company’s moat and potentially harm its operations:

It is important to keep a close eye on any new policies from the Brazilian government regarding Petrobras or the oil and gas industry in general.

  • Political and Regulatory Risks: As a state-controlled company, Petrobras is highly susceptible to political interference, regulatory changes, and government policies regarding fuel pricing and production mandates. These forces may not prioritize profitability but rather social or political goals, which directly influences Petrobras’s ability to perform well. The country’s elections create uncertainty. It is important to keep an eye on Petrobras’s and Brazil’s political landscape.
  • Commodity Price Volatility: The biggest risk for Petrobras is that its revenues and profitability are highly sensitive to fluctuations in global oil and gas prices, which it does not control. In a commodity business, margins may disappear quickly as prices become unstable and competition grows. This is a significant issue.
  • Exploration and Production Risks: Petrobras’s heavy dependence on deepwater and pre-salt oil reserves entails high exploration and production costs. New drilling operations are becoming more complex, more expensive, and sometimes fail to be economical. Project delays, increased drilling costs, and unsuccessful exploration can significantly harm the company.
  • Refining and Infrastructure Risks: Over the next decade, the company plans to make significant investments into new refineries and maintenance and repairs for its existing infrastructure. If those projects are mismanaged or take longer and cost more than expected, the company’s profitability can take a hit. Also, disruptions in the supply chain or an accident at the plants can lead to big losses.
  • Debt Levels: The company has a significant amount of debt, which makes it vulnerable to rising interest rates or a prolonged downturn in the market prices for oil and gas. Rising interest rates will increase interest expenses and reduce profitability.
  • Technological Disruption: While oil and gas has been the dominating source of energy for decades, the shift towards renewable and clean energy represents a major risk to all companies in the industry. Unless Petrobras adapts and diversifies into renewable energy, it will likely see a reduction in profitability as consumers move towards renewable alternatives.

Financial Analysis

Petrobras has historically generated a lot of revenue and high profits in high price environments.

  • Revenues: The company’s revenue structure is tied to the global oil price. When prices go up, revenues go up, and vice versa. It operates across the whole value chain, meaning it deals in extraction, refining, and distribution of oil and gas products. In recent earnings, it highlighted a massive reduction in profit, but that was primarily due to a one time drop in asset valuation of 27 billion dollars.

  • Profitability: The profitability of Petrobras is highly variable, given that it depends on the price of oil. However, when prices are high, the company generates very high profits. Profitability is reduced when commodity prices decrease and also due to high operational costs. The company has been actively engaged in lowering costs and expenses.
  • Returns: Given that the company’s main purpose is generating high returns, it emphasizes a lot on ROIC. The company seems to be focusing on its core businesses and divesting assets that have a low rate of return. This, they believe, will increase shareholder value.

  • Capital Structure: Petrobras has a significant amount of debt, most of which is long-term debt, and it is also actively working on reducing its debt balance and interest rates.

    Balance Sheet Health: 4/5 (Healthy), The company has a lot of assets, but also has a lot of debt. The debt could present challenges if the company’s revenues drop significantly in the future.

Understandability Rating: 3/5

  • Reasoning: Petrobras’s business model is straightforward; they extract, refine, distribute oil and gas products. However, because it is tied to commodity prices and is heavily regulated, there are many moving parts that can affect the company. To truly understand the business requires paying close attention to global energy prices and to the Brazilian political and regulatory systems. Because of these factors, its operations can become very complex. A good understanding of discounted cash flow and valuation is also needed to understand the company’s value. Therefore it’s neither very simple nor very complex for a normal investor to grasp and analyze. Hence, a 3 out of 5 rating seems fair.

Latest Developments and Management Perspective

Petrobras has been increasing dividend payouts substantially in recent quarters, which may point to its management having faith that the company will be generating more profits going forward. They are looking towards growing cash flow in the long term.

  • Divestment: The company is actively involved in divesting noncore assets to streamline operations. This is done to focus on its core business and generate better returns on capital.
  • Pre-Salt Exploration: Petrobras is focused on exploring the pre-salt region and has put in place several programs to further enhance extraction.
  • Share Buybacks: They are now buying shares of the company to prop up the stock price.
  • Future Guidance: Despite a disappointing quarter, the management team at Petrobras believes that the company’s future profitability is still bright due to the large investments that are now operational, and other major projects that should be coming online soon. They believe they will start seeing improved financial results in 2024.

Conclusion

Petrobras presents a mixed bag for investors. The company has a degree of competitive advantages in its domestic market, as well as in the pre-salt areas, but it also faces significant external risks like political intervention, commodity price volatility, technological shifts, and financial stability. This can make the investment a bit of a rollercoaster, but for long term investors that understand the business, this volatility might be a good source of opportunities.

The company’s fundamentals are dependent on the market conditions of the oil and gas markets, as well as on the Brazilian political and regulatory environment. A lot of what will happen to Petrobras in the future is out of the company’s control. Therefore, the company needs to continue focusing on controlling costs, increasing profitability, and reducing debt. It is very important to keep an eye on the company’s financials and the global trends that may influence it.