PETROBRAS CONFERENCE CALL WITH TOP MANAGEMENT
Santander's comments:
Net/Net: We see three implications from today's conference call with Petrobras's management that lead us to maintain our cautious view on the name: (i) the process of selecting a methodology for quantifying the impact of corruption allegations on the company's fixed assets remains complex, and will thus take time; (ii) as a result, the company's ability to publish audited 2014 financial statements-which remains key to this story-remains an important challenge; and (iii) the company will have to dial down its production growth outlook-including for pre-salt-for the next three to five years.
Selection of methodology remains complex, and will thus take time, in our view: The task of selecting a methodology that accurately identifies the impact of the alleged corruption on the company's fixed assets-while meeting the requirements set both by regulators (SEC, CVM) and auditors (PricewaterhouseCoopers)-is a challenging task, in our view, and one that will take time to resolve. However, Petrobras does have a key timeline to stick to, in that bond covenants require audited 2014 financial statements by June 30, 2015. We illustrate below why this process remains so complex and thus difficult:
* Methodology #1: Average Percentage of Improper Payments (3%, according to depositions): This method (which estimated a loss of R$4.06 billion) was not selected, since the number, size, and length of the projects under investigation could increase. In other words, the challenge here is that since the corruption investigation is ongoing, the number of projects involved could increase.
* Methodology #2: Fair Value (book value minus fair value equals value of correction): Our understanding is that Petrobras recommended to its board of directors not to use this methodology, as the comparison between the fair value (calculated using a replacement cost and a discounted cash flow approach) and the book value did not isolate the amount related to corruption and, therefore, was not an adequate proxy.
* New Methodology #3: a new approach not yet defined? The company explained that it will examine another methodology that takes into account values, deadlines, and information from the depositions, while being in compliance with requirements set by the regulators (SEC and CVM) and auditors (Pricewaterhouse).
Size of impairment. The CEO explained that although the R$88.6 billion already incorporates the biggest projects analyzed by the company so far, the number could change based on ongoing investigations. The cost and timing of the investigation are as follows: they will cost Petrobras around R$150 million, and according to expert consulting firms in this field, given the size of Petrobras, could take one to two years to conclude. Of note, among the 31 assets with a fair value below their book value (adding up to R$88 billion), 13 were in refining, 13 were in exploration and production, and 4 were in gas & energy. In addition, among the 21 projects with a fair value higher than the book value (totaling R$27 billion), 6 were in exploration and production, 7 in gas & energy, and 8 in refining.
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Publication of the 2014 audited statements remains key. Here lies a significant challenge for Petrobras in this whole process, in our view: although the investigation is ongoing and methodologies have not yet been agreed to or impairment size finalized, the company needs to publish 2014 audited financial statements by June 30, 2015 (see details below) in order to meet the covenants in some of the bonds and bilateral debt. Although the company could obtain a waiver-as it has done in the past-the pressure remains great on this front, in our view. Of note, our understanding is that Petrobras's bond holders could potentially accept audited 2014 financial statements that include exceptions, as long as the company can show that these exceptions are being actively addressed.
--Bilateral Debt: requires audited 2014 financial statements within 120 days after the end of 2014, plus 30 or 60 days of the grace period, that is, May 30 or June 30, 2015.
--Bonds: require audited 2014 financial statements within 120 days after the end of 2014, plus 60 days of the grace period, that is, June 30, 2015.
Important implications of surprisingly low production target for 2015. In our view, growing concerns about the company's ability to continually obtain financing (i.e., can Petrobras generate enough cash flow to fund capex?) are pressuring down the company's production growth expectations not just for 2015, but likely for 2016-20. For example, the just-announced 2015 production growth projection of 4.5% (+/- 1%) was fueled by several elements listed below, the most important one, in our view, being the need to be realistic and conservative in order to ensure cash flow generation and thus adhere to the company's goal of not having to access the capital markets in 2015. The other reasons for the lower 2015 target are as follows: (i) the second most significant reason for the lower 2015 target is the downward revision of the P-55 and P-62 potential due to water injection issues, and the unexpected heterogeneity and compartmentalization of the reservoir; (ii) the impact of delays and lower level of platform completion by shipyards in 2014; (iii) the decommissioning of the production of the FPSO Marlim Sul based on supplier issues; and (iv) delay in the installation of P-61 due to severe weather conditions. Another important implication is that even the expectations for pre-salt-the engine of production growth in the long term for the company-are being dialed down. The company is now using more conservative productivity numbers for pre-salt than previously. Another example of this conservatism is that the company has increased its estimate of maintenance stoppages in 2015 from 30 kbpd in 2014 to 50 kbpd in 2015, in order to make sure that the 2015 production target is met.
Update of strategic plan not expected until mid-2015. Although the timing does not surprise us, given all the company is going through, the mid-year timeframe (versus February last year) does not help the story, since the market is seeking as much visibility as possible not just for 2015, but particularly as it relates to the company's production curve in 2016-19.
No cuts in gasoline and diesel prices. The CEO explained that irrespective of the current premium vs. international prices, prices will be maintained during 2015, even if it implies small losses in market share.
Cuts in capex in 2015 included trimming exploration capex to a minimum as well as reducing capex for COMPERJ, among others. In our view, these actions are badly needed given the company's very large five-year capex plan, the recent drop in oil prices, and Petrobras's current inability to access the capital markets (since it has not published audited 2014 financial statements), although the company argues that it will not need to raise debt, for example.
Debt financing? The CEO sees no need to raise debt in 2015, based on management's cash flow generation expectations. Management reached this conclusion assuming a 2014 year-end cash balance of US$25 billion, higher than our estimates.
https://twitter.com/LatamEnergyLLC
Dividend policy outlook. The CFO explained that under a financial distress scenario, the company could choose to pay no dividends. We believe the risk exists of zero dividends on the ONs. Our understanding is that (i) if the company generates zero net income, it does not need to declare and pay dividends; or (ii) if it generates a profit, it can declare a dividend but pay it at a later date (requires BOD and shareholders' assembly approval, and the creation of a special reserve). Regarding the dividends for the PNs, although Petrobras's bylaws state that the company should pay the maximum of three criteria (5% of the paid-in-capital represented by this class share, 3% of book value, or 25% of net income), the interpretation of the Brazilian S.A. Law could lead to a different conclusion on this front, opening a door that could cause the company not to pay dividends, if it reports a loss in 2014. In our view, there exits some ambiguity interpretation on this topic between Petrobras' bylaw and Brazilian S.A. Law regarding the dividend payment for preferred shareholders.
Divestments. Could reach around US$3 billion in 2015.
Source: Santander
Selection of methodology remains complex, and will thus take time, in our view: The task of selecting a methodology that accurately identifies the impact of the alleged corruption on the company's fixed assets-while meeting the requirements set both by regulators (SEC, CVM) and auditors (PricewaterhouseCoopers)-is a challenging task, in our view, and one that will take time to resolve. However, Petrobras does have a key timeline to stick to, in that bond covenants require audited 2014 financial statements by June 30, 2015. We illustrate below why this process remains so complex and thus difficult:
* Methodology #1: Average Percentage of Improper Payments (3%, according to depositions): This method (which estimated a loss of R$4.06 billion) was not selected, since the number, size, and length of the projects under investigation could increase. In other words, the challenge here is that since the corruption investigation is ongoing, the number of projects involved could increase.
* Methodology #2: Fair Value (book value minus fair value equals value of correction): Our understanding is that Petrobras recommended to its board of directors not to use this methodology, as the comparison between the fair value (calculated using a replacement cost and a discounted cash flow approach) and the book value did not isolate the amount related to corruption and, therefore, was not an adequate proxy.
* New Methodology #3: a new approach not yet defined? The company explained that it will examine another methodology that takes into account values, deadlines, and information from the depositions, while being in compliance with requirements set by the regulators (SEC and CVM) and auditors (Pricewaterhouse).
Size of impairment. The CEO explained that although the R$88.6 billion already incorporates the biggest projects analyzed by the company so far, the number could change based on ongoing investigations. The cost and timing of the investigation are as follows: they will cost Petrobras around R$150 million, and according to expert consulting firms in this field, given the size of Petrobras, could take one to two years to conclude. Of note, among the 31 assets with a fair value below their book value (adding up to R$88 billion), 13 were in refining, 13 were in exploration and production, and 4 were in gas & energy. In addition, among the 21 projects with a fair value higher than the book value (totaling R$27 billion), 6 were in exploration and production, 7 in gas & energy, and 8 in refining.
https://www.facebook.com/latamenergyadvisors?fref=photo
Publication of the 2014 audited statements remains key. Here lies a significant challenge for Petrobras in this whole process, in our view: although the investigation is ongoing and methodologies have not yet been agreed to or impairment size finalized, the company needs to publish 2014 audited financial statements by June 30, 2015 (see details below) in order to meet the covenants in some of the bonds and bilateral debt. Although the company could obtain a waiver-as it has done in the past-the pressure remains great on this front, in our view. Of note, our understanding is that Petrobras's bond holders could potentially accept audited 2014 financial statements that include exceptions, as long as the company can show that these exceptions are being actively addressed.
--Bilateral Debt: requires audited 2014 financial statements within 120 days after the end of 2014, plus 30 or 60 days of the grace period, that is, May 30 or June 30, 2015.
--Bonds: require audited 2014 financial statements within 120 days after the end of 2014, plus 60 days of the grace period, that is, June 30, 2015.
Important implications of surprisingly low production target for 2015. In our view, growing concerns about the company's ability to continually obtain financing (i.e., can Petrobras generate enough cash flow to fund capex?) are pressuring down the company's production growth expectations not just for 2015, but likely for 2016-20. For example, the just-announced 2015 production growth projection of 4.5% (+/- 1%) was fueled by several elements listed below, the most important one, in our view, being the need to be realistic and conservative in order to ensure cash flow generation and thus adhere to the company's goal of not having to access the capital markets in 2015. The other reasons for the lower 2015 target are as follows: (i) the second most significant reason for the lower 2015 target is the downward revision of the P-55 and P-62 potential due to water injection issues, and the unexpected heterogeneity and compartmentalization of the reservoir; (ii) the impact of delays and lower level of platform completion by shipyards in 2014; (iii) the decommissioning of the production of the FPSO Marlim Sul based on supplier issues; and (iv) delay in the installation of P-61 due to severe weather conditions. Another important implication is that even the expectations for pre-salt-the engine of production growth in the long term for the company-are being dialed down. The company is now using more conservative productivity numbers for pre-salt than previously. Another example of this conservatism is that the company has increased its estimate of maintenance stoppages in 2015 from 30 kbpd in 2014 to 50 kbpd in 2015, in order to make sure that the 2015 production target is met.
Update of strategic plan not expected until mid-2015. Although the timing does not surprise us, given all the company is going through, the mid-year timeframe (versus February last year) does not help the story, since the market is seeking as much visibility as possible not just for 2015, but particularly as it relates to the company's production curve in 2016-19.
No cuts in gasoline and diesel prices. The CEO explained that irrespective of the current premium vs. international prices, prices will be maintained during 2015, even if it implies small losses in market share.
Cuts in capex in 2015 included trimming exploration capex to a minimum as well as reducing capex for COMPERJ, among others. In our view, these actions are badly needed given the company's very large five-year capex plan, the recent drop in oil prices, and Petrobras's current inability to access the capital markets (since it has not published audited 2014 financial statements), although the company argues that it will not need to raise debt, for example.
Debt financing? The CEO sees no need to raise debt in 2015, based on management's cash flow generation expectations. Management reached this conclusion assuming a 2014 year-end cash balance of US$25 billion, higher than our estimates.
https://twitter.com/LatamEnergyLLC
Dividend policy outlook. The CFO explained that under a financial distress scenario, the company could choose to pay no dividends. We believe the risk exists of zero dividends on the ONs. Our understanding is that (i) if the company generates zero net income, it does not need to declare and pay dividends; or (ii) if it generates a profit, it can declare a dividend but pay it at a later date (requires BOD and shareholders' assembly approval, and the creation of a special reserve). Regarding the dividends for the PNs, although Petrobras's bylaws state that the company should pay the maximum of three criteria (5% of the paid-in-capital represented by this class share, 3% of book value, or 25% of net income), the interpretation of the Brazilian S.A. Law could lead to a different conclusion on this front, opening a door that could cause the company not to pay dividends, if it reports a loss in 2014. In our view, there exits some ambiguity interpretation on this topic between Petrobras' bylaw and Brazilian S.A. Law regarding the dividend payment for preferred shareholders.
Divestments. Could reach around US$3 billion in 2015.
Source: Santander
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