Petrobras: Management Reshuffle Brings A Lot Of Questions (NYSE:PBR)

Overview

Since Lula de Silva has been elected as new Brazilian president, Petrobras’ (NYSE:PBR) stock is on a downward trajectory. Petrobras stock lost over 35% from its peak, reached in mid-November 2022, and it is clear underperformer among its peers. Petrobras trades only for 3.3x FY2023 expected earnings and looks extremely cheap on fundamental basis. Nevertheless, stock seems to be cheap for right reasons and in the near future there aren’t many catalysts which would prove otherwise.

Management reshuffle

Previous week, Petrobras informed that, at the time, current CEO, Mr. Caio Mario Paes de Andrade, agreed to early termination from his position. New role as a CEO will undertake, Jean Paul Prates, initially a senator for Lula’s Workers’ Party. Mr. Prates will be the 11th CEO of Petrobras since the Lula’s first government. Even though, Mr. Prates is considered to be an expert in the energy sector, he has been known as a critic of current management. Mr. Prates confirmed that practice of changing domestic fuel prices in line with international markets should change and new price guidelines will be created. Petrobras has been often criticized by politicians from Workers’ Party for its inability to transition into renewable sources of energy. It is expected that Mr. Prates will work on this transition. This naturally brings a lot of unknowns in the eyes of the investment public, especially in terms of future investments and profits.

Change in business strategy

In recent years Petrobras has been standing between rock and the hard place. It has been hailed by investors for delivering high dividends and criticized by the government for not doing enough in fixing high oil prices and focusing on renewable projects. Its strategy was focusing on the most profitable oil projects on one hand and selling of lower profitability assets on the other. This strategy has led to increasing dividends and slashing its debt. Investors cheered this development and stock price rose accordingly. Since the election of new Brazilian president, there was a major U-turn in its business strategy and in a way how Petrobras should look like in next five to ten years. New Brazilian energy minister stated that Petrobras should focus on expanding country’s refining sector. Problem with building new refineries is that they take years to build. In the meantime, several factors can change in terms of demand – supply dynamics, not to mention arrival of new government with different priorities.

Additionally, in recent weeks several government representatives stated that Petrobras should follow other global oil majors in investments in renewables. This idea is not new, but was abandoned by previous management as it would distract their attention from higher profitable projects in pre-salt oil fields.

At the moment, there is not a clear idea how final business strategy will look like, however from what is publicly known, it will be much different than what investors were used to in past two years. In words of Peter Lynch, Petrobras is undertaking all steps in diworsification of its business. It wants to be present in businesses with limited operational efficiency and instead it might lose its edge in the business where it has competitive advantage.

Portfolio positioning

How should investors react to current developments? Should they buy, hold, or sell? Clearly, Petrobras trades with a discount to its peers (3.3x FY2023 PE vs. 5.3x PE for peer group). The Brazilian Bovespa trades over 7 times forward earnings. However, Petrobras’ discount is based on consensus numbers, and they can be very volatile and unstable. If somebody was buying Petrobras on the story of profit-oriented management, increasing dividends, and lowering debt, then this story is not valid anymore. Petrobras can eventually turn into valuation play. If investors see that new business strategy is not so destructive as it seems, then some more reasonable valuation multiples can be applied. I would expect that some minor repricing is possible, but I wouldn’t expect the repeat of last two years in terms of price appreciation. For me, Petrobras belongs into category “wait and see”, but unfortunately it is no more in the category “buy and never sell”.