Petrobras (PBR) Shares Decline After Debt Cut to Junk at Moody's

Petrobras (NYSE: PBR) declined Wednesday after its credit rating was cut to junk at Moody's. Shares are poised to open lower by about 8%. Moody's press release is below.

Moody's Investors Service today downgraded all ratings for Petrobras S.A. (including debts rated based on Petrobras' guarantee), including a downgrade of the company's senior unsecured debt to Ba2 from Baa3, and assigned a Ba2 Corporate Family Rating (CFR) to the company. Moody's also lowered the company's Baseline Credit Assessment (BCA) to b2 from ba2. These rating actions reflect increasing concern about corruption investigations and liquidity pressures that might result from delays in delivering audited financial statements, as well as Moody's expectation that the company will be challenged to make meaningful reduction in its very high debt burden over the next several years. The ratings remain on review for downgrade.

Below is a list of affected ratings:

Downgrades:

..Issuer: Petrobras Global Finance B.V.

....Subordinate Shelf, Downgraded to (P)Ba3 from (P)Ba1; Placed Under Review for further Downgrade

....Senior Unsecured Shelf, Downgraded to (P)Ba2 from (P)Baa3; Placed Under Review for further Downgrade

....Senior Unsecured Regular Bond/Debenture, Downgraded to Ba2 from Baa3; Placed Under Review for further Downgrade

..Issuer: Petrobras International Finance Company

....Subordinate Shelf Shelf, Downgraded to (P)Ba3 from (P)Ba1; Placed Under Review for further Downgrade

....Senior Secured Shelf, Downgraded to (P)Ba1 from (P)Baa2; Placed Under Review for further Downgrade

....Senior Unsecured Shelf, Downgraded to (P)Ba2 from (P)Baa3; Placed Under Review for further Downgrade

....Senior Unsecured Regular Bond/Debenture, Downgraded to Ba2 from Baa3; Placed Under Review for further Downgrade

..Issuer: Petroleo Brasileiro S.A. - PETROBRAS

....Backed Preferred Shelf, Downgraded to (P)B1 from (P)Ba2; Placed Under Review for further Downgrade

....Preferred Shelf, Downgraded to (P)B2 from (P)Ba3; Placed Under Review for further Downgrade

....Subordinate Shelf, Downgraded to (P)Ba3 from (P)Ba1; Placed Under Review for further Downgrade

....Senior Secured Shelf, Downgraded to (P)Ba2 from (P)Baa3; Placed Under Review for further Downgrade

....Senior Unsecured Shelf, Downgraded to (P)Ba2 from (P)Baa3; Placed Under Review for further Downgrade

Assignments:

..Issuer: Petroleo Brasileiro S.A. - PETROBRAS

.... Corporate Family Rating, Assigned Ba2; Placed Under Review for further Downgrade

Withdrawals:

..Issuer: Petroleo Brasileiro S.A. - PETROBRAS

.... Issuer Rating, Withdrawn , previously rated Baa3

RATING RATIONALE

The downgrade of Petrobras' rating and the lowering of its BCA reflects continued concern about the potential for serious near term liquidity pressure, as well as Moody's view that the company is likely to take longer than previously expected to achieve planned leverage reductions that are needed for a material improvement in its financial profile.

Moody's does not perceive substantial progress that would significantly reduce concern about the potential for payment acceleration under debt agreements that require the provision of audited financial statements. On February 12, the company informed the local stock exchange commission that it planned to release audited annual financial statements before the end of May, which is 30 days after the due date. Moody's understands that the company is focusing on actions that are under its control and working with its auditor to provide these statements as soon as possible and is also taking steps to bolster its liquidity profile. However, Moody's does not yet see any concrete assurance that audited statements will be available by any particular date.

The company's high capital spending in recent years resulted in persistent negative free cash flow and increased debt. Recent years, in which elevated capital spending led to substantial growth in debt, were expected to be followed by a period in which the company significantly deleveraged using the cash flow generated from increased production. While the maintenance of high prices for refined products in Brazil is currently helping to cushion Petrobras from the decline in global oil prices, the gap between domestic and global prices will likely not be sustainable over a longer period. The company has repeatedly fallen short of certain financial and production targets and Moody's no longer expects significant improvement in leverage over the medium term.

In 2015, Petrobras may generate higher cash flow than in 2014 because its downstream business is benefitting from the current large spread between low international crude prices and high domestic refined product prices, and this may more than offset the negative impact of low oil prices in its exploration and production business segment. However, even with planned reductions in capital expenditures, Moody's expects that cash flow from operations will not cover capital spending, resulting in yet another year in which free cash flow is negative in the absence of any substantial asset sales. Curtailment of capital spending to conserve cash could also lead to production falling short of previously planned targets in the future. Moody's expects leverage, as indicated by debt/EBITDA, to remain above 5 times for a sustained period of time in the absence of substantial asset sales. Moody's adjusted debt/EBITDA ratio is high at about 5.3x.

The company's ratings also reflect the challenges related to the corruption investigations, which create management distractions that may hinder efforts to improve operations as well as ongoing concerns about corporate governance and the need to sustainably improve internal controls.

Petrobras' ratings remain on review for downgrade, reflecting continued concern about potential liquidity pressures that could arise as a consequence of not providing timely financial statements. The company's obligations to provide financial statements under the terms of various debt agreements include the provision of audited annual statements by April 30, 2015. Extended delay carries the risk that creditors could take actions that lead to a declaration of technical default, followed by payment acceleration after the relevant cure period under the particular agreement. Additional rating actions will consider any further developments in the ongoing corruption investigation along with Moody's assessment of progress towards timely delivery of audited financial statements and actions, if any, that are perceived as lessening the risk of a creditor default notice followed by acceleration.

If the company is able to conclusively address its near term liquidity risks, its ratings could be upgraded, although likely not to investment grade because the company is expected to face continuing stresses related to the corruption investigating and its very high debt burden.

Petrobras' rating would be sensitive to any change in the government's rating as well as to Moody's assessment of the strength of support from the government. Moody's credit assessment of Petrobras takes into account the expected level and timeliness of government support, in case of need. Moody's currently assumes a high likelihood of support and moderate dependence with the government's rating. This support assumption reflects, inter alia, the government's stated willingness to stand behind Petrobras should that be needed. However, Moody's also recognizes that the government could be challenged to ensure provision of the funding needed to ensure timely payment of Petrobras' obligations in a scenario in which a substantial portion of the company's debt was accelerated. Should the likelihood of such a scenario materializing increase, Moody's would likely lower its assessment of support to reflect the rising threat to timely support, even if the government's willingness to ensure ultimate recovery remained unchanged.

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