With $21B in Forex Losses, Petrobras' (PBR) Hedge Accounting Poses Dividend Risks, Says Deutsche Bank

In a research note Monday, analyst Alexander Burgansky of Deutsche Bank discussed hedge accounting at Petrobras (NYSE: PBR). In his view, the company's hedge accounting poses dividend risks, and he suggested its $21 billion in forex loses could be a "time bomb." In his view, Petrobras may partially discontinue hedge accounting.

Burgansky explained, "Hedge accounting has become a material part of Petrobras’s investment story. With a notional value of $58bn and unrecognized after-tax forex losses of $21bn, hedge accounting will have a material impact on the company’s future reported earnings, dividends, and equity valuation. We think it is likely that Petrobras may partially discontinue hedge accounting in 2015, which would increase the likelihood of an accounting loss in 2015, reducing the likelihood of a preferred dividend being declared. While the dividend risk has increased, we still see future dividend stream more supportive of the valuation of preferred shares (Hold) than of ordinary shares (Sell)."

The analyst continued, "Petrobras is currently hedging $58bn of its designated “highly probable” future $-denominated exports. We believe recent events may require Petrobras to reassess the size of the hedge as some its future exports may have become less probable in light of a change to production growth outlook and lower oil prices. In this case Petrobras may be required to discontinue – at least partially – the use of hedge accounting, which may result in an immediate recognition of a portion of its $21bn unrealized forex loss in its income statement."

Burgansky added, "If Petrobras were to continue using hedge accounting, it will have to start reclassifying the gigantic $21bn unrealized forex loss (after tax) into its income statement starting from 2016, significantly depressing its accounting earnings for the next nine years (until 2025). Can this outcome be considered consistent with the original purpose of hedge accounting? If so, the company’s earnings will be depressed for years to come, delaying the first ordinary dividend until 2018, we estimate."

Deutsche Bank maintained a Sell rating on Petrobras (NYSE: PBR).

For an analyst ratings summary and ratings history on Petrobras click here. For more ratings news on Petrobras click here.

Shares of Petrobras closed at $4.79 yesterday.

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