Highlights

Recently, there is a growing concern on Petrobras’ credit prospect as the company’s credit default swaps (CDS) continued to surge after the company goes deeper into debt to finance its record US$237bn spending spree. Debt has increased from US$89bn in 2Q12 to US$112bn in 2Q13 with net gearing of 0.52x.

Petrobras plans to spend $237bn between 2012 and 2016 to develop fields off the coast of Brazil containing 50bn barrel of crude. 60% or $142bn will be allocated for exploration and production. (Refer Fig1). While Mexico is seeking to loosen its oil monopoly to attract foreign investment, Brazil is forcing Petrobras to operate all new projects in the ultra-deep waters or known as pre-salt, where it will hold at least a 30% stake of every field. This mean apart from its current US$237bn capex plan, Petrobras will need to fork out US$50bn more to develop Libra, the world’s largest crude discovery this century which further burden its financial capability.

Comment

Given the uncertainty on the Petrobras’ financing ability, investors are concern the spillover effect to SapuraKencana as 50% of its outstanding orderbook (~US$ 4.1bn) is from Petrobras. We gather from management that the Petrobras’ first contract is on track and will commence by 4Q14 (second contract will commence by 2Q16). Management sees little risk of contract default from Petrobras given its good payment track record with Seadrill. Even in the event of contract default, there’ll be penalty term attached in the contract.

Petrobras has loosen its local content requirement given that is has allowed all three vessels to be build overseas in the second contract as compared to at least one required to build in Brazil in the first contract. This is to speed up the pipeline installation and ensure production on time. During our company visit with Pantech in Johor, we understand that it’s subsidiary in UK, Nautic Steel has seen increasing order from Petrobras and do not see any sign of slowing down which further ease our concern.

In our view, it is important for Petrobras to ensure production commence on time which will increase its future cash flow and reduce the debt level. Given the US$237bn spend from 2012- 2016, Petrobras expect net debt/EBITDA to surpassed limit of 2.5x in 2013 but fall below 2.0x after 2015. In addition, press recently reported that Brazil’s government is planning to finance Petrobras’ investment in Libra. At current crude oil price of US$108, the ROI on the pre-salt project remain attractive given the breakeven price is between US$40- 45/barrel.

Risks

Execution risk,

Escalation of vessel, fabrication and drilling costs.

Rating

BUY

Positives – Strong balance sheet and knowhow, global trend towards offshore production.

Negatives – Increased competition for growth markets, complexities of running a larger organization.

Valuation

Maintain BUY call with an unchanged TP of RM4.74 based on 20x EPS of 23.7 sen/share based on FY01/15 EPS.

Source:Hong Leong Investment Bank Research - 27 Sep 2013