Brazilian state-owned oil and gas company Petroleo Brasileiro SA or Petrobras (NYSE:PBR) has outperformed the S&P 500 (SPX) since our December update, urging investors to ignore the doom and gloom.
Despite the recent pullback, PBR is still up by nearly 20% from our article’s published price, relative to the SPX’s 3.5% uptick.
However, sellers swarmed in, pushing back against further upside in late January, coupled with Brazilian President Luiz Inacio Lula da Silva (or Lula) publicly criticizing the country’s central bank.
Accordingly, Lula was displeased with the central bank’s inflation targets, currently at 3.25% for 2023. Central bank chief Roberto Campos Neto has instituted a relatively successful inflation-fighting regime over the past year, bringing its inflation rate down to 5.8%.
However, the central bank also expects to keep its policy rate at 13.75%, holding it steady to allow more time for inflation to fall further towards its target rate.
As such, Brazilian equity investors have had to deal with significant volatility over the past month, as investors are likely concerned whether the government would intervene with the central bank’s autonomy.
While that doesn’t seem likely for now, the high interest rates could deal Lula’s ability to spend and lift public spending a critical blow as he seeks to fulfill his election promises.
Therefore, we believe the impasse between the government and the monetary policymakers will likely continue to pressure PBR in the near term, even as it deals with its operational and management reshuffle.
Keen investors should recall that Petrobras’s new CEO Jean Paul Prates has yet to announce any decisive plans that could set about potentially destroying shareholder value by investing more into less profitable downstream assets.
However, with Lula’s man firmly on board, investors need to be prepared as it could affect the company’s adjusted EBITDA profitability if the government is keen to expand its downstream capacity.
Recent underlying weaknesses in the energy markets could have alleviated some near-term pressure for the government to act expeditiously, buying investors some time to reassess Petrobras’ outlook further.
Coupled with the Prates’ announcement earlier this year that the company will not deviate significantly from international pricing benchmarks, it has alleviated some near-term headwinds against further downside risks.
PBR last traded at an NTM EBITDA multiple of 2.1x, in line with the two standard deviation zone below its 10Y average of 2.2x. In other words, PBR remains priced with highly significant pessimism.
It’s also in line with its NTM Dividend yield of 25.7%, suggesting market operators are putting all options on the line, including a potential dividend cut.
With Lula under pressure to deliver his campaign promises, we believe investors must be prepared for the unexpected.
However, the market is forward-looking and seems to have astutely priced PBR accordingly, with the reward/risk attractive.
Nevertheless, PBR’s price action warrants caution for now.
We gleaned that PBR failed to regain control over its critical 20-week moving average or MA (red line) and 50-week MA (blue line).
Notably, PBR’s recovery from its late December lows was rejected by sellers at its late January highs, reversing its trend bias toward the downside.
Therefore, investors may want to consider waiting for a constructive consolidation zone predicated on oversold levels before taking the plunge against its highly pessimistic valuation.
Investors already in the game can consider holding on to their positions and ride out the near-term volatility while anticipating a further pullback to buy more.
Rating: Hold (Revised from Buy).