Earnings Miss for Petrobras

Brazil's state-run energy giant Petroleo Brasileiro S.A., or Petrobras ( PBR - Analyst Report ) announced third quarter profit of R$5.6 billion or R$0.43 per share, compared with earnings of R$6.3 billion or R$0.49 in the year-earlier quarter. Earnings per ADR came in at 42 cents (1 ADR = 2 shares), below the Zacks Consensus Estimate of 67 cents. During the corresponding period last year, Petrobras earned 60 cents per ADR.

Petrobras’ net operating revenues of $36.4 billion were down 6.3% from the third quarter 2011 level.

The company’s results were dragged down by persistent weakness in its refining unit.

Segmental Performance

Upstream: Total oil and gas production during the third quarter of 2012 reached 2,523 thousand oil-equivalent barrels per day (MBOE/d), from 2,579 MBOE/d in the previous quarter and 2,581 MBOE/d in the same period of 2011.

Compared with the third quarter of 2011, Brazilian oil and natural gas production decreased 2.3% to 2,281 MBOE/d, while international production came in at 242 MBOE/d (as against 247 MBOE/d in the year-ago period).

During the third quarter of 2012, the average sales price of oil in Brazil fell 1.0% from the year-earlier period to $101.80 per barrel. Average sales price of international oil was up 1.9% year over year, reaching $90.42 per barrel. Regarding natural gas, average international sales price increased 9.6% from the third quarter of 2011, while domestic price was down 12.6%.

Exploration costs skyrocketed 64.6% to R$1.3 billion.

Notwithstanding the lower volumes and higher costs, the company’s upstream (or exploration & production) segment profit improved by 4.5% to R$10.8 billion. This can be attributed to lower write-offs associated with unproductive or sub-commercial wells.

Downstream: During the third quarter, Petrobras’ downstream unit incurred a net loss of R$5.7 billion, much wider than the loss of R$3.2 billion a year ago. This was due to the company’s inability to shift the burden of rising oil costs to its consumers, as mandated by the state policy of keeping a lid on gasoline and diesel prices.

Though the company raised its wholesale fuel price in late June, it was not enough to offset Petrobras’ refining losses. Higher product import cost also hampered results.

Refining costs per barrel in Brazil were down 10.3% to $4.62. Internationally, it decreased 1.4% to $4.28. Petrobras exported an average of 563,000 barrels of oil per day, 13.3% lower compared to the same period last year.

Capital Spending & Balance Sheet

During the three months ended September 30, 2012, Petrobras’ capital investments totaled R$21.1 billion. At the end of the quarter, the company had cash and cash equivalents of R$30.2 billion and net debt of R$133.9 billion. Net debt-to-capitalization ratio was approximately 28%.

Rating & Recommendation

Petrobras – which aims to surpass Exxon Mobil Corporation ( XOM - Analyst Report ) by 2020 to become the world’s largest oil producer – currently retains a Zacks #4 Rank (short-term Sell rating). We are also maintaining our long-term Underperform recommendation on the ADR.

The Rio de Janeiro-headquartered company – whose second quarter loss was its first in 13 years – has been reeling from the effects of rising costs and heavy fuel imports. We also remain concerned about Petrobras’ huge investment requirements, the possibility of heightened state interference and caps on local fuel prices. Partially offsetting these negatives are the company’s strong pipeline of development projects and impressive exploration successes, as well as exposure to Brazil’s economic growth and huge pre-salt oil reserves.