We initiate coverage of Petroleos Brasileiros or Petrobras’ family of bonds with a Buy recommendation (ticker: PETBRA). 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 and carry on increasing production, which should be rewarded by investors with higher bond prices.
On the other side of the coin, we continue to see a deteriorating PEMEX with a dubious business plan, the need for more government support, and continued challenges on the production and margins fronts. We believe that the qualitative differences between these two credits justify our view that PETBRA bonds have more upside potential, while PEMEX bonds (Hold) remain riskier and vulnerable to potential events such as further downgrades and deteriorating performance.
We believe that if PEMEX were to lose its investment-grade status from another agency, the forced selling of those bonds (from what we call ‘downgrade holdouts’) would probably result in investment flows into Petrobras that could make spreads even tighter.
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 (Ba2/BB-/BB-) currently trading at cUS$109.443 (ALLQ) to yield 4.64% (G-Spread 292 bps; Z-Spread 302 bps), because these bonds are among the most liquid within the company’s credit curve and its intermediate maturity and duration (6.8 years) in the current environment of falling rates.
We also particularly like the company’s US$2.623bn (out of an originally issued amount of US$2.75bn), 5.75% Senior Unsecured bonds due 2029 (Ba2/BB-BB-) currently trading at cUS$107.666 (ALLQ) to yield c4.73% (G-Spread 299 bps; Z-Spread 310 bps) and duration of 7.5 years. We like these bonds for the same reason as the 2028s: high liquidity, intermediate maturity and duration, and what we believe is an adequate return that could tighten further as the company continues to improve its balance sheet and operations..
With the Lava Jato scandal mostly behind us, the company has refocused on increasing production, increasing its liability management actions, strengthening its balance sheet, and improving its governance. These factors, coupled with what we believe has been an increase in appetite for PETBRA – at least to some extent a factor of the problems at its comparable PEMEX – have resulted in substantial price appreciation and spread compression for PETBRA bonds. However, we believe that an additional set of asset sales, lower capex needs and further cost efficiencies still leave room for additional positive price action.
PETBRA reported stable Q2 19 results (see page 3 for details). Petrobras expects further increases in production that should result in strong quarters ahead and set the stage for a positive ratings action towards the end of the year, something we believe is long overdue.