The Petrobras soap opera
Fans of television drama programming might be impressed by the scandal going on at Petrobras. Over the past few months Brazil's largest company, formally known as Petroleo Brasileiro SA, has repeatedly made headline news with allegations of corruption, bribery and sweeping political misbehaviour. Serious criminal charges, numerous arrests and charges of fraud have led to an entire reshuffling of the company's management.
Brazil's once stalwart blue-chip company has seen its stock and bond prices plunge in the wake of growing uncertainty about its current and future profitability. With a large portion of its $135 billion of debt held by foreigners, bond investors have been demanding increasingly higher rates of interest to compensate for the mounting risks. Some market commentators are comparing the Petrobras situation to British Petroleum in the midst of its infamous Macondo oil spill debacle, when the UK's largest energy company faced massive legal and financial liabilities ultimately forcing the company to eliminate its stock dividend while its share price tumbled.
Earlier this year the plot thickened when Petrobras failed to provide financial statements for the latest quarter. Delayed financials are never a good thing for a public company and that's when investors began to vote with their feet. Later it was discovered that company officers participated in a graft scheme involving former managers, top construction workers and political parties including the party of the current president, Dilma Rouseff.
Prosecutors have been aggressive in arresting and jailing executives of high profile contractors to the company. Every good scandal deserves a moniker and this one earned a title known widely as “Operation Carwash”. Defendants have been accused of misconduct action, or “acao de improbidade” in Portuguese, marking the first time companies have been brought to justice rather than individuals.
Adding to the company's woes, global oil prices have been cut in half since last summer severely reducing the company's main source of revenue. Even prior to this most recent crisis, Petrobras had been disparaged by investors as being too tightly controlled by the government. Critics observed the government made the oil company to sell petroleum products at below market rates, effectively subsidising energy prices for the people. That policy helped the populous but worked to the detriment of shareholders and creditors.
In an attempt to shore up the crisis, Rousseff stepped in to make some changes; after all, the Brazilian government is the Petrobras's largest shareholder. While many investors had hoped for an outsider to clean up the mess, Rouseff appointed Aldemir Bendine, a 35-year veteran of another state-controlled corporation, Banco do Brasil SA as CEO.
Given the relative size and ownership structure of the South American oil giant, the issue has now become much larger than the company itself. Indeed, Brazil's economic growth has stumbled in recent years and the country's status as a rising emerging economy remains challenged. Rouseff has been given a second chance in office after narrowly winning last year's election, but many consider her to be an ineffective leader.
Rouseff is under pressure to prove herself in her second term. Certainly the swift response in quickly ousting the oil company's management team was a step in the right direction. While Bendine might be an insider to the political system at least he has had some proven success in running the country's largest bank. Moreover, his background as a banker should be helpful in producing accurate financial statement within the extended deadline.
Bond investors loath risk and Petrobras bonds have sold off hard. Moody's downgraded the bonds one notch below investment grade in late February, but by that time they had already been trading like ‘junk' securities. Petrobras bonds maturing inside of a year and pay around seven per cent as of this writing. This yield represents a substantial premium compared to short-dated US dollar Brazilian sovereign debt which paying less than two per cent.
Bond analysts are divided. An Oppenheimer analyst likes the credit at these levels. “The spread to the sovereign is too wide,” Omar Zeolla, an analyst at the firm, who's been covering emerging-markets for more than a decade, recently stated. “Once things start to clear up a little bit, it will start to trade better.” Brazil could provide “debt guarantees and so forth to make it easier for the company to get funding”. However, JP Morgan researchers believe further downside risk is possible, especially if the company cannot produce its financial results on time.
Will Brazil use this setback as an opportunity to prove to the world that it can overcome difficulties and create better corporate and sovereign stewardship? Or, will Brazil be pulled down farther into the ranks of yet another mismanaged South American banana republic shunned by investors like Venezuela and Argentina? Stay tuned for more exciting episodes.
Bryan Dooley, CFA is a senior portfolio manager at LOM Asset Management Ltd in Bermuda. Please contact LOM at 441-292-5000 for further information. This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their Brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority.