By Itau BBA.

Petrobras reported far worse than expected 2Q12 results. EBITDA came in at only BRL 10.6 billion, way below our BRL 14.5 billion forecast and the BRL 15.6 billion consensus. For the first time in 13 years, the company reported a net loss of BRL -1.3 billion. The feeble numbers are attributable to: i) increased oil-product imports; ii) higher lifting costs; iii) higher exploration expenses due to dry wells; iv) inventory write-offs in the U.S.; and v) monetary variation losses. The bulls may again argue about the recurrence of expenses like dry wells or the non-cash impact of monetary variation, but we cannot fight the numbers! The weaker operational performance generated an impressive cash burn (BRL 13.6 billion) in the quarter, accelerating indebtedness much faster than expected. Net debt/total net capital reached 28% (+400 bps QoQ), while net debt/EBITDA reached 2.46x. We expect a very negative market reaction to the results.

The results: Although net revenue matched our forecast at BRL 68 billion, EBITDA lagged behind our forecast (BRL 3.9 billion) by 26% at BRL 10.6 billion. The difference is split between COGS and operating expenses. COGS surpassed our expectations by BRL 2.4 billion, namely due to the higher impact of oil product inventories built at higher prices and the all-time-high lifting costs. Oil-product imports were flat quarterly. Inventories were therefore burned to supply the domestic market. Despite the BRL depreciation, lifting costs increased 3% to an all-time-high of USD 13.4/bbl due to maintenance and well interventions. Higher operational expenses are responsible for the additional difference to our EBITDA forecast. The company booked BRL 3.4 billion in exploration expenses, compared with a recurring number of BRL 1 billion. The significant increase is related to wells drilled between 2009 and 2012 in blocks that will probably be relinquished to the ANP. There was also a BRL 0.5 billion extraordinary expense related to the write-off of inventories in foreign refineries. Even if we add the full BRL 2.4 billion in exploration expenses, arguing non-recurrence, the EBITDA would still be below both our and consensus forecasts. The weaker operational performance led Petrobras to record a net loss of BRL -1.3 billion versus our BRL 2 billion forecast, adding to the negative BRL -7.5 billion monetary variation impact already expected for the quarter.

The weak operational performance resulted in an impressive cash burn of BRL 13.6 billion in a single quarter, causing indebtedness ratios to increase much faster than expected. Net debt/total net capital reached 28% (400 bps QoQ) against the 35% investment grade limit, while net debt/EBITDA reached 2.46x, very close to the 2.5x threshold. Capex in the quarter totaled BRL 20.6 billion.

Investment implications: We maintain our market-perform recommendation and YE12 fair value of BRL 26.5/PETR4 (USD 27.9/PBRA). Petrobras posted a better performance after the unexpected increase in diesel prices, which we believe prompted expectations of another increase in gasoline prices, causing investors to avoid big underweights on the name. We reinforce our view that the change in senior management significantly improved the communication between Petrobras and the government.  However, the inflation scenario in Brazil that ultimately allowed for the diesel increase has deteriorated rapidly over the last few weeks, reducing the room for an increase in gasoline prices at the pump in the short term, in our view. We are now left with these results and an increasing possibility of a drop in yearly production. We therefore expect a negative correction of the recent stock performance.

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