Is Petroleo Brasileiro Dividend Safe?

Sometimes the best deals don’t lie within US shores but in far away fields. That certainly seems to be the case with Petroleo Brasileiro (NYSE:PBR), which stands out on numerous front now as being an attractive play.

But is there something looming in the background that might hurt shareholders? After all, how can the 19.78% dividend be sustainable? 

Petroleo Brasileiro produces and sells oil and gas in Brazil. For a stock that is trading in the mid-teens, you might expect it’s in the midst of some fundamental turmoil. In fact, operating income each quarter continues to be reported in the billions. Last quarter alone, management announced $7.8 billion following sales of $24.8 billion. 

The quality of the earnings is high and free cash flows are far exceeding net income. Levered free cash flow last quarter came in at $8.1 billion while dividends cost the company $4.7 billion. 

Upon crunching the numbers, the dividend payout ratio is 71% suggesting, remarkably, that the near 20% dividend is in fact sustainable, at least at first glance.

So, what could derail the bullish investment thesis?

A primary concern for shareholders is how net income will be affected by a continued decline in sales. The top line has fallen by 26.6% year-over-year in the most recent quarter and that followed a 33.4% YoY fall in the prior quarter.

As the price of oil is a significant driver of revenues, it’s clear that higher commodity prices will be needed to spark a resumption of the bullish trend.

Still, there is lots to like on the PBR profit and loss statement. For example, gross margin last quarter came in at 53.1%

The real question is whether the balance sheet is a fortress or set to crumble. As Peter Lynch has famously observed, a brittle balance sheet is typically the precursor to a crumbling share price. In the case of PBR, the cash on hand last quarter sat at $12.06 billion, a massive sum but notably less than 3x the quarterly dividend amount.

Where concerns really spike is on the debt side of the balance sheet. Long-term debt now sits at $60.7 billion, an astonishingly large amount, especially in a higher interest rate environment where interest payments could really act as a drag on cash levels in coming year.

Some analysts forecast that inflation increases now are in the midst of a secular rising trend, so the recent dip in bond yields is temporary. If so, Petroleo Brasileiro could be chugging down the tracks and on course to hit a brick wall in the coming years. That realization could spook shareholders and cause price declines to exceed the lofty dividend yield.

All that said, the valuation does look compelling. But first, how safe is the high yield now?

Is Petroleo Brasileiro Dividend Safe?

Petroleo Brasileiro 19.78% dividend appears safe at this time given the 71% payout ratio, high cash on the balance sheet, and billions in operating income each quarter.

What could derail the sustainability of the dividend is a spike in interest obligations that burn through the $12 billion cash pile over the medium-term.

If oil prices were to rise in the interim, however, revenues are likely to return to levels seen last year and the year prior, which in turn would support an increase in net income, free cash flows, and lead to heightened dividend safety.

With relatively high confidence in the yield, does PBR stock have upside potential?

Is Petroleo Brasileiro Stock Undervalued?

According to the 12 analysts covering Petroleo Brasileiro, the upside is 12.8% to fair value of $16.45 per share.

Notably, a discounted cash flow analysis reveals a much higher upside potential of 54% to an intrinsic value of $23 per share, though, that is probably somewhat optimistic given that DCF calculations typically rely on long-term growth rates, and, if anything, oil stocks tend to show a lot of volatility given their dependence on oil prices.

Even if the cash flows calculation is a bit too optimistic, there is enough to like to attract investors. Take the P/E ratio of 3.5x for instance and the return on invested capital of 21.4%, both very attractive to value investors.

Another really compelling metric is the return on equity that sits at 36.1% currently. And as you look across other ratios, more good news can be found, such as the return on assets of 13.9% while trading at 1.2x book value.

If there is one glaring drawback, it would be the forecasted revenue CAGR over the next five years of -12.4%, suggesting Petroleo Brasileiro might soon become what Buffett and Munger would describe as a cigar butt stock, it has a few puffs left in it.

Is PBR Stock a Buy?

It’s rare to find a stock that has a low earnings multiple, very high ROIC and ROE, impressive ROA and sky high dividend producing billions in operating income.

But no stock is perfect and the big red flag for Petroleo Brasileiro is the sliding top line, which is the most important line item on the income statement.

One counterbalancing force to sliding revenues would be found if oil prices return to higher levels and in turn boost sales and operating income.

In the overall, PBR could probably be best categorized as a cigar butt stock that could deliver some decent returns to investors given the yield appears safe, and the short-term sustainability of it looks to be in no jeopardy.

As such, a few puffs could still be left before interest rates start to drag down cash levels, but conservative investors should be wary of the stock over the long-term. It has the potential to disappoint.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.