Petrobras (PBR), Electrobras (EBR) Lower as S&P Cuts Outlook to Negative

Petroleo Brasileiro S.A. (NYSE: PBR) and Eletrobras - Centrais Eletricas Brasileiras S.A. (NYSE: EBR) are lower following a ratings outlook change issued last night.

Standard & Poor's Ratings Services revised its outlooks on both companies to negative from stable. The outlook revisions follow an identical outlook revision on the sovereign ratings on the Federative Republic of Brazil. At the same time, we affirmed our 'BBB' ratings on Petrobras and 'BBB' foreign currency and 'A-' local currency 'A-' ratings on Eletrobras.

The outlook revision reflects the similar action on the outlook of the sovereign rating on Brazil and is in line with our criteria for government-related entities (GREs). Because we view the likelihood of extraordinary government support for Eletrobrás as "almost certain," we equalize the ratings on the company with those on the sovereign. Similarly, we view the likelihood of extraordinary government support to Petrobras as "very high," which, under our criteria, allowed us to assign a one notch of support to the company's stand-alone credit profile (SACP). Both companies would be downgraded if a similar action is taken on the sovereign, as their SACPs are currently lower than the sovereign foreign currency rating.

We base our view of "almost certain" likelihood of government support to Eletrobrás on the following factors:

• Eletrobras' "critical" role as a financial agent for its subsidiaries in the Brazilian electric power sector and as manager and controlling entity of federal assets; and
  
• The "integral" link with the government, given its majority equity stake in Eletrobras.

We base our view of a "very high" likelihood of government support to Petrobras on the following factors:

• Petrobras' "very important" role as both Brazil's main oil producer, a key sector with high growth prospects, and its main fuel distributor, with a correlative effect on inflation; and
  
• The company's "very strong" link to the government, which owns 50.2% of Petrobras' voting shares (65.4% when we account for sovereign-related entities like the Brazilian Development Bank, the Brazilian sovereign wealth fund, and other government entities' support for the company's investment program.).

The SACPs for both Eletrobrás and Petrobras remain unchanged, at 'bbb-'.

Eletrobrás' SACP reflects its "satisfactory" business risk profile and "intermediate" financial risk profile. These profile assessments reflect the company's exposure to the Brazilian regulatory environment, its subsidiaries' heavy capital expenditures, which will require it to provide some financial support, and the strong influence of the federal government on the company's strategic planning.

Petrobras' SACP reflects its "satisfactory" business risk profile and "intermediate" financial risk profile. It also reflects the company's strong exploration and production (E&P) activities (size, quality, lifetime, and good replacement level of reserves), dominant market position in all aspects of the Brazilian hydrocarbon industry, more limited geographic diversification compared to global peers and sizable capital expenditure plan resulting in projected negative free operating cash flow (FOCF) at least until 2015.

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