Petrobas

Extract from Portfolio Manager Commentaries – Sept 2022

Petrobras, the partly state-owned Brazilian oil company returned 28% in the quarter. Most of this return was due to dividends – Petrobras paid around $3.20 in gross dividends per ADR during the quarter on an opening ADR price of $11.60. This equates to an astonishing dividend yield of 27% in one quarter alone as oil prices were very high in the first half of the year and Petrobras was able to pay out these super profits as dividends. The realised return from dividends in the Fund would have been a bit lower due to various withholding taxes, but the overarching point - that the share is incredibly cheap at current oil prices - remains relevant. Petrobras trades on 3x earnings and, due to limited large scale required capital expenditure, converts all of this into free cash flow, which equates to a 33% forward dividend yield. Investors place such a low valuation on this asset due to a combination of expected declines in the oil price and the prospect of left winger Lula da Silva returning to the presidency after the second round of elections due on the last Sunday of this month (October). While both of these do pose a risk to Petrobras, we believe they are more than compensated for in the current share price. Due to the limited capital investment programme at Petrobras - the company spent the last decade developing one of the biggest oil finds in recent history - Petrobras is still highly cash generative, even at $70 a barrel, which we believe is below a ‘normal’/sustainable oil price due to significant underinvestment in developing new oil fields around the world since the Global Financial Crisis. Oil fields have reducing yields over time, and with many developing nations having seen their output fall (Venezuela, Nigeria, Iran), a glut of oil that suppresses prices is unlikely to occur on a sustained basis. With respect to the potential return of Mr. da Silva, it is worth noting that his first stint in the presidency (2003-2010) was fairly centrist in nature and the congressional elections returned a slight majority for allies of the incumbent (pro-business) president, who will limit the potential for damaging intervention at Petrobras. The above all said, political risk does exist, and this reality results in the position size being limited in our funds in spite of the very cheap valuation.