The Financial Times had an article this morning debating the merits of Pemex bonds, suggesting “investors are increasingly tempted by what they say are enticing prices”.
We are not tempted. We believe that PEMEX bonds remain vulnerable to further downgrades and deteriorating performance. As we said in our report on 30 July, Pemex’s management has tried to put a positive spin on the Q2 results, but the numbers speak for themselves: they show continued deterioration, operationally and financially.
The Pemex paradox
We have a Hold on Pemex bonds for purely technical reasons. We think Pemex bondholders will continue to see the company as a quasi-sovereign, following what we have labelled the ‘Pemex paradox’, which we define as the fact that the worse the company gets, the more likely it becomes that the federal government will intervene and even accelerate its rescue strategies.
The Ministry of Finance has announced that it will be tapping c40% of Mexico’s “Rainy Day Fund” in order to meet the goal of a primary surplus, and as a result of slower economic growth and lower tax collections. This suggests that the government might have less “ammunition” than originally believed to shore up Pemex’s finances. After all, we want to believe that the federal budget and the sovereign public finances would take precedence over possible additional financial needs at Pemex. If this were the case, it would underscore the notion that another Pemex downgrade might come sooner than many investors believe.
With such a downgrade, the timing of the much sought-after entry point would perhaps be more evident. But we are not there yet.
We prefer Petrobras (PETRBRA) bonds, on which we have a Buy recommendation. While this might seem counter-intuitive on a relative value basis, considering that PETBRA bonds are trading tighter than higher-rated peer PEMEX, we base our recommendation on the trend. We expect Petrobras to continue to improve, strengthen its balance sheet further, carry on increasing production and make more non-core asset sales to continue to pay down debt and improve its leverage ratios even further. These actions should be rewarded by investors with higher bond prices. Within the whole PETBRA family of bonds we particularly like the US$4.719bn (originally issued amount was US$5.40bn), 5.999% Senior Unsecured bonds due 2028. See our initiation report on Petrobras for more details.
We think the qualitative differences between Pemex and Petrobras justify our view that PETBRA bonds have more upside potential.