Petrobras – Century Bond

Team member: Duo Cao, Xiaojun Kong, Chao Tang, Luping Zhang, Shengjie Zheng

The following analysis is about Petrobras, an oil company operating in the oil, natural gas, and
energy industries in Brazil. The company issued a 100-year bond in 2015 which has a
considerable coupon rate. As bond analysts of an insurance company, we consider investing the
100-year bond to make the maturity of assets match the maturity of liabilities. Duration and
convexity are used to analyze 10-year, 30-year, and 100-year bonds. According to the bond
analysis, firm analysis, other firm comparable analysis, and macro analysis, we suggest not to
buy the 100-year bond. The following article explains the research and assumptions in details.

Bond analysis
The chart (Exhibit 1) shows the main characteristics of 100-year, 30-year, and 10-year bonds.
The cash flows equal to the bond prices, which are $86.00, $95.08 and $100.20 respectively.
Duration is calculated as the weight average of the times to each coupon payments. To be more
precise, we use YTM to modify the MacAulay Duration, which is 12.55, 11.29 and 4.94.
Duration measures the interest rate risk, and a high duration value shows a high interest rate. In
this perspective, the risk of a 100-year bond is highest, with a 12.55 modified duration. And 10-
year bond’s duration is only 4.94, which has the lowest risk. Convexity reflects the rate of
change of the slope of the price-yield curve. And investors normally desire a high convexity,
because a high convexity means the higher benefit with decreasing interest rate and lower loss
with increasing interest rate. And the 100-year bond has a higher convexity with 315. Comparing
the 100-year and 30-year bond, the price of the 100-year bond is better than that of the 20-year
bond with 100 basis point yield change.

Firm Analysis
To analysis the current standing of the company, we need to focus on some financial metrics of
Petrobras for its solvency. Some short-term ratios and long-term ratios are shown in Exhibit 2.
The current ratio which measures the company’s ability to pay obligations is 1.89 in 2017 while
the cash asset ratio is 0.98. Basically, higher current ratio lowers liquidity risk. The current ratio
with growing trend indicates that Petrobras has enough to cover its current liabilities if they are
theoretically due immediately. In the long run, the debt ratio is 43.47% which is appropriate.
However, the debt to equity ratio of Petrobras in 2017 is 104.05%. Typically, it shows a growing
trend of leverage ratio from 2011 to 2017, resulting in volatile earnings. The company becomes
aggressive in financing its growth with debt. The international rating agency downgraded its
bond rating which illustrates a negative situation. Moody’s LT Corp downgraded from Ba2 to
Ba3, while Standard & Poor’s downgraded from BBB- to B+.

Other Firm Comparable Analysis

There are four comparable companies, Chevron Corp (CVX), Gazprom PJSC (GAZP), China
Petroleum & Chemical Corp (SNP), and ConocoPhillips (COP). First, we use bond rating to
compare their ability to pay the coupons. We calculate the median values from 2013-2017 of
selected ratios for each firm to judge the bond rating. The outcome refers to Exhibit 3. We use
Moody’s Financial Metrics bond rating class as criteria (Exhibit 4). None of these firms have a
rate over Baa, which means all bonds may be classified as a junk bond. To be specific, four of
these companies get a C rate except for Gazprom PJSC, B rating. We can conclude that
Petrobras, CVX, SNP, and COP all perform worse than GAZP to pay the coupons. The outcome
seems dangerous. So, we also take data from the firm’s financial reports into consideration. We
use Altman’s Z-scores model to calculate every firm’s Z-scores (Exhibit 5). We can find that both
target company Petrobras and comparable firm COP have a Z-scores below 1.23, which means
vulnerability to bankruptcy. However, the Z-sores of other three comparable companies, CVX,
GAZP, and SNP, is between 1.23 and 2.90, which indicates a grey area. In conclusion, none of
these companies are safe from bankruptcy and have adequate ability to pay the coupons. What’s
more, Petrobras doesn’t have an obvious advantage over comparable companies, which means
the bonds all of the five firms are not so worthy of investing.

Macro Analysis
We should consider all the three factors in the macro environment. If general interest increases,
Petrobras would suffer from holding loss of its bond investment. And an upswing future oil price
in real term could enhance Petrobras’s profitability, building up the confidence of the investment
in a 100-year bond. Besides, currency risk is significant, because dollar depreciation would lower
the return from the bond investment in USD when translating into Brazilian real. So the macro
environment could significantly influence the return on the Petrobras 100-year bond.

Conclusion
Based on our comprehensive analysis, we suggest that should not buy the Petrobras 100-year
bond. Although the 100-year bond has the highest convexity, the company does not worth
investing for its current forecasted operation condition. Petrobras is now assessed to be
vulnerability to bankruptcy and may not be able to repay its debt. Since the industry Petrobras
operates is relatively in a maturity stage, there would be not much growth in the future. In
addition, the current macro environment is quite dynamic for a long-term investment, especially
in a foreign country. High risk exists in this long-term bond issued by Petrobras.

Exhibit1 Three Bonds Analysis

100-year bond 30-year bond 10-year bond
Cash flow $86.00 $95.08 $100.20
MacAulay Duration 13.05 11.73 5.10
Modified Duration 12.55 11.29 4.94
Convexity 315 203 29
Price change with 100 basis point decrease $12.34 $11.78 $5.10
 Price change with 100 basis point increase -$9.59 -$9.84 -$4.81
Exhibit 2 Petrobras Financial Ratios
2017 2016 2015 2014 2013 2012 2011 2010
Current ratio 1.89 1.80 1.52 1.63 1.49 1.70 1.78 1.89
Cash ratio 0.98 0.88 0.90 0.83 0.56 0.70 0.77 0.99
43.47
Debt Ratio % 47.93% 54.75% 44.25% 35.57% 29.34% 25.92% 22.43%
Debt to equity (%) 104.05 124.17 151.83 90.67 63.33 44.44 29.27 17.85

Exhibit 3 Comparable Companies Ratios

Petrobra Chevron Gazprom China Petroleum ConocoPhillip
s Corp PJSC & Chemical Corp s
EBIT/Assets (%) 4.56% 0.66% 7.97% 5.42% 2.18%
Operating profit margin (%) 12.76% 1.32% 22.38% 3.54% 5.50%
EBITA to interest coverage (multiple) 1.83 0.00 20.33 9.46 7.69
Debt/EBITDA (multiple) 6.83 4.97 3.27 4.14 5.04
Debt/(Debt + Equity) 67.58% 41.29% 33.32% 46.54% 58.02%
Funds from operations/Total debt 0.061 0.223 0.213 0.192 0.076
(multiple)
Retained cash flow/Net debt (multiple) 0.03 -0.10 0.17 0.31 0.05
Bond Rating C C B C C

Exhibit 4 Bond Rating S tandards

Aaa Aa A Baa Ba B C
EBIT/Assets (%) 20.9% 15.6% 13.8% 10.9% 9.1% 7.1% 4.0%
Operating profit margin (%) 22.0% 17.1% 17.6% 14.1% 11.2% 8.9% 4.1%
EBITA to interest coverage (multiple) 28.9 15.1 9.7 5.9 3.5 1.7 0.6
Debt/EBITDA (multiple) 0.58 2.03 1.83 2.58 3.41 5.26 8.35
Debt/(Debt + Equity) 19.3% 50.2% 38.6% 46.2% 51.7% 72.0% 98.0%
Funds from operations/Total debt (multiple) 1.335 0.385 0.425 0.296 0.206 0.120 0.031
Retained cash flow/Net debt (multiple) 1.3 0.3 0.4 0.3 0.2 0.1 0.0

Exhibit 5 Comparable Companies

Financial Characteristics of Petrobras Chevron Gazprom China Petroleum & ConocoPhillips
FY2017 Corp PJSC Chemical Corp

EBIT/Total assets 0.053 0.007 0.046 0.057 0.022

Sales/Assets 0.341 0.503 0.359 1.442 0.397
Shareholders' equity/Total 0.480 1.429 1.931 1.148 0.724
liabilities
Retained earnings/Total assets 0.000 0.686 0.633 0.330 0.401
Working capital/Total assets 0.088 0.003 0.048 -0.032 0.097
Z-Scores 0.771 1.709 1.886 2.357 1.179
Vulnerability Gray area Gray area Gray area Vulnerability to
Indication
to bankruptcy bankruptcy