Petrobras (PBR) Soars 40% Year To Date: More Room Ahead?

2018 is turning out to be a favorable year for Petróleo Brasileiro S.A. or Petrobras (NYSE:PBR) , with its share price surging almost 40% year to date compared with the industry’s gain of 21%.

Headquartered in Rio de Janeiro, Petrobras is the largest integrated energy firm in Brazil and one of the largest in Latin America. This Zacks Rank #3 (Hold) stock, with a market cap of $61.8 billion, carries a VGM Score of B. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The company expects to deliver year-over-year growth of 124.62% and 15.38% in its earnings and sales, respectively, in 2018.

Petrobras’ committed efforts to improve its liquidity and operational efficiency, along with its ambitious five-year plans make us optimistic about the stock.

Pre-salt Reservoirs to Drive Production

Brazil has huge oil reservoirs that lie below the Espírito Santo, Campos and Santos basins in deep and ultra-deep water. These reserves, estimated to hold 50 billion barrels, are widely thought to be the most important oil finds in recent years. Petrobras is the operator in most of these exploration areas and holds interests in the range of 20-100%. Considering this, we believe that Petrobras is in an enviable position to maintain an impressive production growth profile for years to come.

The state-run company produced 2.15 million barrels per day (bpd) of oil in 2017, higher than 2016’s volumes. In the pre-salt layer, average annual production — including the company's partners' portions — was 1.29 million bpd, representing a 26% year-over-year increase, driven by Santos Basin’s Lapa and Lula fields.

Notably, per its ambitious five-year plans, the Brazilian oil giant intends to boost average production from an expected 2.7 million barrels of oil equivalent per day (Boe/d) in 2018 to 3.55 million Boe/d by 2022. The plan will be supported by the eight platforms going into production in 2018 and 11 more coming online by 2022.

The company is also entering into various strategic partnerships with foreign oil giants to drive exploration momentum. In this regard, Petrobras has inked deals with major players like TOTAL S.A. (NYSE:TOT) , Royal Dutch Shell (LON:RDSa) plc RDS.A and Statoil (OL:STL) ASA (NYSE:STO) .

Debt-Reduction Plans Instill Confidence

Petrobras, burdened with huge debt load, has laid strong emphasis on its debt reduction in its recent five-year Business Management Plan (2018-2022) to strengthen its credit rating. As it is, Petrobras’ net debt decreased 8.5% to $88,143 million from the $96,381 million figure as of Dec 31, 2016. Net debt-to-capitalization ratio in the last quarter was 51%, down from 55% nine months ago.

The company targets in achieving a net debt to adjusted earnings before interest, tax, depreciation and amortization (EBITDA) ratio of 2.5 in 2018, which was as high as 5.3 in 2015.

Cost-Cut and Divestment Bode Well

Petrobras’ successful cost cut initiatives and aggressive divestment programs are helping it in its endeavor to trim the debt load. During the nine months ended Sep 30, 2017, Petrobras’ capital investments and expenditures totaled $10,528 million, sharply lower than $11,590 million incurred in the year-ago period. Also, over the past year, the company cut its workforce by 12% through a voluntary separation program.

Petrobras is concentrating on improving its liquidity and operational performance of late. Petrobras generated free cash flow of $4,657 million in the last quarter -- positive for the 10th quarter in a row -- reflecting operational improvement and lower investments. The company has plans to reduce its operating expenses to $136.8 billion from $153 billion projected in the five-year plan earlier. Also, operating cash generation is estimated to be around $141.5 billion, after dividends. Successful implementation of these cost-control initiatives is likely to help it in reducing its debt without drawing new funds.

Petrobras aims to revive its financial health through divestments and spin offs, thereby gaining additional liquidity as it intends to increase investment in ultra deepwater projects. The company’s divestment program of $21 billion throughout 2017-2018 is expected to help reinstate its financial health by mitigating the leverage.

Better Liquidity Push Up Credit Ratings

In February 2015, Petrobras lost its investment grade at Moody’s Investor Service due to severe corruption charges against the company. In February 2016, the company was downgraded to the lowest speculative level. However, in October 2016, Moody’s had upgraded the company’s ratings to B2.

In April 2017, Moody’s raised the company’s corporate debt rating by one level to B1. Further in October 2017, the rating agency further upgraded the ratings to Ba3 from B1 on the back of liquidity improvement and reducing leverage metrics. The company’s debt refinancing transactions and disciplined operational management also attributed to the ratings upgradation and positive outlook.

In December 2017, Petrobras successfully managed to raise $1.5 billion in an IPO for its fuel distribution unit, Petrobras Distribuidora S.A. In the same month, it also won a financing deal with China Development Bank worth $5 billion to be matured in 2027. These developments signify that the company has emerged from the threat to its credit rating caused by the multibillion-dollar money laundering and bribery case.

Upward Estimate Revisions

Analysts have increased their estimates for the company, which makes the earnings picture favorable for 2018. Over the past 30 days, two estimates have gone up against no downward revisions for 2018. This has caused the Zacks Consensus Estimate to trend higher, from $1.29 30 days ago to its current level of $1.48.

But with large, multinational energy firms looking to reign in their skyrocketing capital expenses, the drilling space is witnessing intense competition, as multiple firms chase a single contract. This will continue to impact the earnings adversely in the near to medium term.

Final Thoughts

While the company has been making serious efforts to trim its leverage metrics, one can’t deny the fact that its involvement in the Operation Carwash scandal has been a major overhang for the company, which scarred its credit metrics and turned it into the world's most-indebted oil company. Though the company’s rating is gradually improving, it is still two levels away from the investment grade ratings.

Notably, in January 2018, Petrobras agreed to pay $2.95 billion to settle class-action lawsuits filed by investors and put to rest one of the Brazil’s most notorious cases of fraud. Though the settlement will be reflected in the company’s fourth-quarter 2017 results and put some pressure on its results, it does remove uncertainty regarding Petrobras’ liabilities, enabling it to plan better how to use the future cash flow.

The Hottest Tech Mega-Trend of All

Last year, it generated $8 billion in global revenues. By 2020, it's predicted to blast through the roof to $47 billion. Famed investor Mark Cuban says it will produce "the world's first trillionaires," but that should still leave plenty of money for regular investors who make the right trades early.

See Zacks' 3 Best Stocks to Play This Trend >>