Petroleo Brasileiro SA Petrobras (PBR, Financial), also known as simply Petrobas, is an integrated energy company controlled by the Brazilian government.
The Rio de Janeiro-based company focuses on the exploration and production of oil and gas in Brazilian offshore fields. However, it explores and sells oil and gas not only In Brazil, but also internationally. The business segments include Exploration and Production, Refining, Transportation and Marketing and Gas and Power.
The energy company was founded in 1953 and now, after 70 years of business, its shares are very interesting to watch for two main reasons: a very high dividend yield and a very attractive valuation.
A massive forward dividend yield is ideal for passive income generation
Petrobras shares closed on July 19 at $13.53 with a forward dividend yield of 42.86%, a market capitalization of $88.24 billion and gains of nearly 43% so far in 2023. Receiving a high dividend and getting such a significant stock price appreciation is an ideal scenario in investing as total return expands.
Looking at dividend growth, it is impressive to note the one-year growth rate is 63.6% and the three-year growth rate is 217.1%. What is also interesting is that the payout ratio of 0.97 is considered too high. The frequency of dividends also fluctuated from quarterly to semi-annually to annually and then back to semi-annually in 2020 and 2021. They returned to a quarterly rate in November of 2022.
Income investors need to have a stable dividend frequency to generate passive income, so it is good to see that Petrobras has returned to a quarterly dividend distribution. The company has not reduced it dividend since 2020.
However, Chief Financial Officer Sergio Caetano Leite told reporters earlier this week the company will likely base its second-quarter dividends on a new policy that is being prepared by a working group. He noted studies for the new policy should be completed by the end of the month and will then be voted on by the board of directors.
"Petrobras will have dividends in line with those of its peers," he said.
What will this new policy be, and what are the odds of a dividend decrease for Petrobras? A first estimate is that, as the energy sector's average yield is 4.24%, Petrobras will reduce its dividend.
Will this potential dividend cut be a bad thing for the stock? Not necessarily, as the company generates a lot of positive free cash flow. It has a three-year growth rate of 211.1%, which is highly impressive and can support future special dividends.
Strong fundamentals and attractive valuation
Petrobas has a GF Score of 92 out of 100, which means it has high outperformance potential on the back of solid ratings for four of the five criteria.
The company's net margin for the quarter that ended in March was 27.42%, which is ranked better than 79.07% of 965 companies in the oil and gas industry.
While energy companies tend to have a lot of debt, Petrobas' debt-to-equity ratio of 0.67 is well below the 1 threshold and its interest coverage ratio of 16.09 is very healthy.
Turning my focus to valuation, Petrobas shares trade with a price-sales ratio of 0.65, a price-to-free cash flow ratio of 2.05 and a PEG ratio of 0.07. Since each of these metrics are well below the industry median, I see a lot of value in the stock.
Further, based on historical ratios, past financial performance and future earnings projections, the GF Value of $17.86 indicates the shares are modestly undervalued.
The GF Value indicates there could be 32% upside potential on the horizon, which is very significant.
Top business risks
There are some risks that also need to be considered: commodity price volatility, regulatory and political uncertainty and debt concerns.
As an oil and gas company, Petrobras is highly exposed to fluctuations in global commodity prices. Changes in international oil prices can significantly impact the company's revenue and profitability. Sudden drops can lead to lower revenue and cash flows, affecting the company's ability to fund its operations and investments. Additionally, fluctuations in natural gas prices can also impact the company's overall profitability.
Petrobras is a state-controlled company and, as such, it is susceptible to regulatory and political risks. Changes in government policies, regulations or tax laws could affect its operations, pricing mechanisms and profitability. Political instability, corruption investigations or any form of government interference can also pose challenges to the company's business environment.
Like many capital-intensive companies in the oil and gas industry, Petrobras has a significant amount of debt on its balance sheet. The company's ability to manage and refinance its debt depends on various factors, including interest rates, credit market conditions and financial performance. A deterioration in the company's financial health or an increase in borrowing costs could lead to increased financial leverage and affect the company's credit rating.
Despite the above risks, I believe Petrobras is well-positioned for future growth. Even with a potential dividend cut, the stock should continue to perform well throughout 2023.
