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Edited Transcript of PRIO3.SA earnings conference call or presentation 4-Nov-19 1:00pm GMT

Q3 2019 Petro Rio SA Earnings Call

Rio De Janeiro Nov 7, 2019 (Thomson StreetEvents) -- Edited Transcript of Petro Rio SA earnings conference call or presentation Monday, November 4, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Francilmar Francisco Fernandes

Petro Rio S.A. - COO & Member of Management Board

* Nelson de Queiroz Sequeiros Tanure

Petro Rio S.A. - CEO & Director

* Roberto Bernardes Monteiro

Petro Rio S.A. - CFO & Member of Management Board

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Conference Call Participants

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* Rodrigo Reis de Almeida

Santander Investment Securities Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen. Welcome to the conference call to discuss third quarter 2019 results of PetroRio. Thank you for standing by. (Operator Instructions)

This event is also being broadcast simultaneously over the Internet via webcast and may be accessed through PetroRio's Investor Relations website at ir.petroriosa.com.br by clicking on the banner 3Q '19 Earnings Release.

Before proceeding, let me mention that forward-looking statements that might be made during this conference call relative to the company's business perspectives, projections and operating and financial goals are based on the beliefs and assumptions of PetroRio's management and on information currently available to the company. Forward-looking statements are not a guarantee of success. They involve risks, uncertainties and assumptions as they are related to future events and therefore depend on circumstances that may or may not occur in the future. Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of PetroRio and could cause results to differ materially from those expressed in such forward-looking statements.

I would now like to turn the conference over to Mr. Nelson Queiroz Tanure, CEO; Mr. Francilmar Fernandes, COO; and Mr. Roberto Monteiro, CFO. Mr. Tanure, please go ahead.

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Nelson de Queiroz Sequeiros Tanure, Petro Rio S.A. - CEO & Director [2]

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Good morning, everyone. Thank you all for participating on our Q3 call. I can see again that there are a lot of PetroRio's employees on this call. And folks, this is excellent. Most of us are shareholders of the company. So it is only natural that we take an interest on the company's results. So it's excellent. And I'm very pleased to see so many of you on board as always.

So to speak about the quarterly results, again, we had a third quarter of sustainable growth across our assets. We completed 6 months with Frade Field under our management. And we were able to improve all health environment and safety indicators of the field that were already very good, and we improved even further. So that's very positive.

Polvo Field continues to operate and to produce with a very positive production that's very satisfactory. And we are now, as we speak, so this will not be reflected in our Q3 results in the middle of a drilling campaign, whose results I hope to be able to share with you all very soon. And lastly, Manati Field, which has also been operating really well like clockwork. Petrobras is the field's operator, and we have a 10% interest in that field. But we are very pleased with the performance of this asset.

I would like to mention just a couple of highlights. For the first time in the company's history, our revenue hit the mark of BRL 1 billion, more than BRL 1 billion. So this is very important. In 5 years of this company, this is the first time that the company exceeds that mark, and we still have 3 months ahead of us. One thing to point out is that the company has been growing, both through acquisitions and by developing the assets that we already have. So this growth that we've been experiencing, which is very positive, is exactly the company's plan to continue to acquire producing assets with an upside potential both in terms of management and efficiency and drilling of wells. And so we have had very positive growth evolution. We had very positive results. EBITDA, again, has been the very best ever for the company to date [our lifting] cost or our cost per barrel. At the end of the day, the best strategy we can have to cope with Brent price variability is to keep our costs as low as possible. We've been successful in this strategy.

By the way, it is worthwhile mentioning that we completed the acquisition of the remaining 18% stake of Frade Field, which belongs to Inpex. This deal took longer than we would have liked, but we came to the closing now. And the asset is 100% ours and soon the results of the field will be reflected in our income statement. For this quarter, this is not yet the case, which makes it very clear that from now on, in other words, as of the fourth quarter, we'll have 70% of Frade's production reflected in our numbers. We still have a lot of good news to come. And we expect to share with you all the results of the drilling of Polvo field. We are starting to examine a possible drilling campaign at Frade Field. This should happen sometime next year, more towards the second half of the year. But we're very excited with the possibility to drill again at that field.

So to conclude, as the CEO, I'm very happy with the company's performance and everyone's engagement and constant dedication. All of us at PetroRio know how difficult it is to integrate a new asset and to have a very safe transition. So I would like to thank all of you who work here at PetroRio as well as all of those who came with the acquisition of Frade Field. And I'd like to thank Chevron for helping us promote a very safe and smooth transition and for being very professional. We can say that because of them and also because of the work by our own staff, we are now able to know the assets really well and to operate it very safely.

With that, I would like to thank all of you, and I now turn the floor to Francilmar. Thank you.

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Francilmar Francisco Fernandes, Petro Rio S.A. - COO & Member of Management Board [3]

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Thank you, Nelson. I'll start talking about the company's operational performance starting on Slide 3. Well, I consider the main highlight of the quarter, the consolidation of PetroRio's operation at Frade Field. We now have no more ties with the prior operator, and at the same time, we now understand more and more of the field's geology so that now we can schedule new operations and initiatives to further improve the field's production. At the same time, we have been effectively managing our lifting costs, already reaching a cost below $23 per barrel, 14% lower than the third quarter of '18 showing that we are on the right track. Operating efficiency at the field remains at satisfactory levels above 98%, which was also the result of our day-to-day work. Synergies are unfolding well. Land and air logistics, the synergies have been duly captured with only a few pending items to be resolved this month and all related to sea logistics. And the beginning of the Polvo drilling campaign, which is already starting.

Moving to Slide 4. We have this map with a general view, showing all assets that we operate, and I would like to focus specifically on production. We can see that Frade Field unlike what would normally have and considering the decline of the field, we can see that. Since PetroRio started to work on the field indirectly and then directly, we have been able to reverse this decline in production. And in June 2019 compared to Q3 '18, we see production increasing by 15%, and this is the result of our work. On the other hand, at Polvo, we see a reduction of production. So this is explained by, one, the difference between peak production, the start-up of production of the wells drilled last year, which is natural for carbonate wells. We have a high initial production with a subsequent decline. And two, the low performance of some submersible pumps, EPS (sic) [ESP] and their failure in the end of September, failure in 2 wells, which impacted production [but not --] Manati Field has performed in a relatively stable fashion, given the clients' demand for gas. So it's a field whose behavior we know quite well. It will deliver as planned.

Moving to Slide 5. We see our lifting cost which shows that we have been doing our part reducing slowly but steadily. We are still on a journey. This is not final yet. We were able to capture a good deal of synergies. And now we have to optimize our resources and apply them to the field, mainly Frade Field. And we continue on our plan to reach a lifting cost of $20 per barrel by the end of December, beginning of next year.

On Slide 6, we will speak a bit about our operational performance. We can see the focus on production of our fields, both Frade and Polvo, and we can see both fields' operating efficiency. We can see operating efficiency at stable and well-controlled levels with no recent red flags. And we can see production with an excellent performance of Frade Field. We are very happy and optimistic about the way in which the field has been responding to our actions. We have some short-term initiatives already implemented such as gas injection wellhead of our cleaning and estimation, the reopening of a well with hydrate formation in addition to actions to improve flow and reservoir management.

For the mid-term, there are a number of initiatives that are underway that we have started to bring about improvements. So there is a plan for [BSW] reduction in some of the wells. We'll have to inject polymers in some products. It's a slightly complex operation that we are planning with the production and reservoir team. Connections to stimulate the wells aiming to increase productivity.

With that, with the activities carried out and completed so far, we can see the considerable increase in Frade's production compared to what was expected considering the natural decline of the field. So we're very happy with that, and we assure that the actions that are being implemented to bring us the expected effects.

On Slide 7, in Polvo's drilling campaign, a change was made to its initial scope given the failure of submersible pumps into wells at Polvo in the end of September, beginning of October. In one well, we just needed to change the EPS (sic) ESP , a natural operation for the field. And in the other, there was also an EPS (sic) ESP failure, but this was a well that had been producing for 10 years. So we have mapped an opportunity for recompletion, which is an operation similar to that, which happened in 2016 in which we accessed a new reservoir behind the casing. This was done in October. The wells started to produce again this weekend, and we'll need a couple of days to better assess production from these wells. In terms of drill schedule, we expect around 60 days for each well. So if we start now, we should go until the end of December, beginning of January to have the results. As for investments, we are expecting approximately $20 million for the first stage. You are very aware of these figures. So now it's just about keeping up, moving on with the project and reaping the fruits in the future.

On the slide about Frade Field, #8. I want to speak about the plans and schedule for the drilling campaign at Frade, which should happen by the end of 2020-2021. We'll refine these plans. We already know the numbers in terms of how many wells we'll drill: 4 production and 3 injection wells. This will be divided into 2 phases, and this is because we have a lot of supplies in our inventory, so we can accelerate the drilling of these first wells. And then later at a second stage, we'll need to commission some items, and it will take a lot longer. So for the first phase, around $190 million, $200 million to get started. And we have this simplified map for you to see where we will drill the producing wells, injection wells, where the current ones are located. I just want to focus on this reservoir where we will drill ODP4, which will be our first producing well. It is a known reservoir and a virgin one as it was never used for production. So we have high expectations for this reservoir.

With this, I turn the floor to the CFO of the company, Mr. Roberto Monteiro, to present our financials. Thank you, and have a good day.

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Roberto Bernardes Monteiro, Petro Rio S.A. - CFO & Member of Management Board [4]

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Thank you very much, Francilmar. I will go over our financial highlights and analyze our financial performance as a whole in Q3.

Well, the first thing I would like to highlight is the company's net revenue, BRL 1 billion in the first 9 months of the year or BRL 1.4 billion in the last 12 months. So 2 very interesting and very strong record marks for the company, which show how well we've been growing and performing. In Q3, more specifically, we had a net revenue of approximately BRL 400 million, a 78% increase over Q3 '18. Our EBITDA of around BRL 215 million, although not the highest and absolute trend that are reported, posted the highest ever adjusted EBITDA margin, which speaks very much in favor of the successful cost reduction campaign that we've been implementing as well as in favor of the acquisition of Frade. And as regards our leverage today, our net debt over EBITDA ratio is at 1.2x. In other words, that leverage reduction mentioned in prior calls is becoming real already.

Please go to Slide 10. The most interesting point to highlight is in the second column related to a financial results of negative BRL 98 million. When we look at this company with its revenue in U.S. dollars and its EBITDA, practically all in dollars, this BRL 98 million of financial expenses which includes BRL 79 million related to foreign exchange variation, this is definitely not concerning to us and has no impact whatsoever in the financial soundness of the company. So I'd say this is a take home message. The company has been performing well with a very strong EBITDA. However, the company's net income was strongly impacted by an accounting adjustment of foreign exchange variation. That does not impact the company's health at all from this analysis as well as both for our results net of IFRS 16 and for our results already considering the effects of IFRS 16.

Moving on to the next slide, Slide 11. We show you 2 very important graphs. The first is our EBITDA per barrel. We hit the mark of $31.5 per barrel. Even with a lower Brent oil price along the third quarter, the company posted the highest ever EBITDA per barrel. So as I mentioned before, this underscores our success in bringing down costs thanks to the synergies between the operations that Frade and Polvo and also the result of the acquisition of Frade in and of itself. This is a field with a very good performance and already had a very low operating cost.

As for our leverage, we are at 1.2x. And it is important to remember that this 1.2x net debt over EBITDA ratio takes into account only 6 months since Frade's acquisition. In the 6 months of Frade's acquisition, consider a 52% working interest at the field. As we disclosed in the beginning of October, our working interest at Frade Field increased from 52% to 70% with no increase in our net debt related to this acquisition. Thus, this level of leverage has nowhere else to go but down.

Now moving to our last slide, the slide on funding. I want to draw your attention to just this loan here on the right from Citibank of $48 million, which is a prepayment of receivables of Frade Field, and we were all very excited about this possibility offered by world-class bank believing in our company.

Well, to sum up this quarter, I guess I have 4 points that I would like to stress. First, the company's financial soundness improved quarter-after-quarter. It continues to improve every quarter. This quarter's bottom line was impacted by foreign exchange variation, both considering IFRS 16 effects and excluding IFRS 16. And IFRS is an accounting rule, which does not impact the company at all, considering that our revenue is dollar denominated as well as our EBITDA.

The cost reduction path that we have set that we have planned and proposed since the beginning of the year is being followed very successfully. This can be seen in our EBITDA margin, in our EBITDA per barrel, in our lifting costs. Basically in any angle you look, we can see that our cost reduction efforts have been very well executed. And finally, the company is gaining more and more muscle to prepare for possible acquisitions, new acquisitions and getting ready to continue to grow.

Well, then thank you very much to all, and I'd like now to start the question-and-answer session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) First question from Rodrigo Almeida, Santander.

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Rodrigo Reis de Almeida, Santander Investment Securities Inc., Research Division - Research Analyst [2]

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My first question has to do with the M&A. Are you considering M&A good opportunities? I would like to have an update regarding what is envisioned for the future. Second question about Frade campaign. I think you gave us a better idea. Now I'd like to know whether you are already negotiating with possible suppliers, vendors, drill providers. If you could give us some color on that, it would be interesting.

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Unidentified Company Representative, [3]

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Well, let me speak about M&A, and then I'll speak about Frade. Our M&A pipeline, and I'm being very general here, has never been so large. There are always many opportunities, and there are many possibilities to allocate capital. Well, many opportunities, of course, never come to fruition. But in addition to the Petrobras divestment program, which is the most traditional one, it's what people normally talk about and participate in, with the other companies in the industry taking advantage of this interesting Brazilian moment when companies are buying large blocks, pre-salt blocks, the majors, right? And with that, they are reformulating their portfolio and starting to divest from fuels, which in the past were unthinkable to let go. But this is a movement that we see as a natural one and with very good eyes for the company. So there are many opportunities out there. We are working on many possibilities for mergers and acquisitions. Our pipeline is quite complete.

As for the Frade campaign, we have designed this campaign. It was divided into 2 stages, as Francilmar mentioned. And obviously, we have started talking with some suppliers, but we haven't placed any formal order yet to the suppliers. We are now at a moment of talking to them to understand pricing, to understand the market and so on and so forth. Frade's drilling campaign will strike next year most likely more towards the middle of the year and the end of the year, and we will be strongly on funding for Frade's drilling campaign.

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Operator [4]

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We have a question by [Rodrigo Sequeira].

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Unidentified Analyst, [5]

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2 questions actually. The lifting cost target of $18, when do you think you will achieve it, in the fourth quarter '19? Second question, thinking about a successful drilling campaign at Polvo and Frade, what would be a possible lifting cost number after both campaigns?

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Unidentified Company Representative, [6]

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[Rodrigo], well, let's speak about cost. Regarding the lifting cost, what we said in the prior call and it remains valid, we'll try to get to $20 consolidated lifting cost for Polvo plus Frade. So this is actually the target that we had for the company and that we are pursuing. Now of course, if we get to a lifting cost lower than $20, it will be more than welcome. So it is always important to think that this number does not take into account production increases resulting from the Polvo or Frade drilling campaign. So the number would be $20 per barrel, considering the company as it is and considering the natural decline of production.

Regarding the lifting cost target after both campaigns, well, since we don't give an oil production guidance after the drilling of the well, I think it's easier to think about our consolidated OpEx. Lifting cost is nothing but a consolidated OpEx divided by the number of barrels produced along a certain period. So when we think about the consolidated OpEx, we should get to a number close to $170 million for 100% of Polvo growth, 100% of Frade. It is important to consider that at Frade, we don't have 100% yet. We have 70% at Frade. So if we were to think about OpEx of the company only, it would be around $150 million, perhaps $145 million. This would be OpEx net for PetroRio. Net for PetroRio means 100% of Polvo plus 70% of -- 70% stake of Frade.

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Operator [7]

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We have one more question by [Rodrigo Sequeira].

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Unidentified Analyst, [8]

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What are the funding options for the acquisition? And what is the status of the bond issuance at Norway -- in Norway?

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Unidentified Company Representative, [9]

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Well, [Rodrigo], regarding funding for acquisitions, since an acquisition is an opportunistic thing, our trend is not to have a totally structured long-term funding pre-acquisition. For us, it is more interesting to use our own resources and if possible doing a bridge loan or a loan based on an existing asset for the acquisition. So this is our funding strategy.

If you think about Frade, what we did was very similar to that. We had funding based on an existing asset, Polvo. So then we used our cash. And we took, I think, wisely a loan, but we were financed partially by Chevron. If you compare that to a bridge loan and now what we are doing, and this is getting to the second part of your question, we are now extending the duration of the Chevron loan and have seen the opportunity of issuing a bond at Norway.

We have -- we are quite advanced in this process of a bond issuance, what we call an information memorandum. And at the right timing, we'll disclose it to the market. Oil Brent at $60, $58 today, the price was increasing, or at least it was before we started the call so that helps. But if we keep the price at $60, $58 and a lot of volatility, it gets a little in the way. So we have to work to find the right timing. And sometimes this is more art than technique, but we are waiting for the right timing for this issuance.

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Operator [10]

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Next question from [Vinícius Ariba].

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Unidentified Analyst, [11]

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Although the lifting cost has been reduced and the EBITDA per barrel increased, cost reduction is not impacting the EBITDA margin, the bottom line. What happened? What are the expected cost reductions resulting from the synergies between Polvo and Frade?

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Unidentified Company Representative, [12]

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[Vinícius], I think that there's a little confusion here, and it is really important that we clarify. The company's lifting cost is dropping dramatically because of our synergies we've captured. We are keeping to our original plan to capture synergies, actually doing a little better than expected. So this drives down the lifting cost. The counterpart of that is that our EBITDA per barrel will increase. And that's why we posted the best ever EBITDA per barrel, even with a lower Brent oil price. So this is very, very healthy for the company.

Now when you talk about the EBITDA margin bottom line, I think you mean the company's bottom line, which would be net income. What exists between EBITDA and net income is a huge impact of foreign exchange variation. We reported our results in Brazilian real, BRL, but all of our debt is dollar-denominated. So when we have a currency variation, fluctuation as it happened in this quarter, we had $1 to BRL 4.20, around that. We report this exchange effect on foreign currency liability of the financial expense, but the company is dollar-denominated. Our revenue is in dollars. Our EBITDA is in dollars. And that's why it doesn't impact at all the soundness of the company.

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Operator [13]

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(Operator Instructions) Next question comes from [William Dudek].

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Unidentified Analyst, [14]

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Could you comment on the provision for decommissioning?

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Unidentified Company Representative, [15]

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[William], yes. Of course. The decommissioning provision works in the following way. What is posted in our balance sheet is a dollar liability for the commissioning of the field. This is an expense or an investment, if you want to call it, that happens at the end of the life span of the field, and this is updated from time to time. So start with Manati. Today, the company is virtually 100% covered regarding the fund for the provision for abandonment or decommissioning. So the company is 100% covered for that. In the case of Polvo -- by the way, there is an explanatory note in our balance sheet about that if you want more on that. But for Polvo, we are practically all covered. There's a good deal of the decommissioning provision for that. We have a provision of $52 million, more than $40 million given as guarantee. And what you see in the balance sheet is net for PetroRio.

And then what we have there in the balance sheet, what you saw in the closing of September was 52% of the provision for decommissioning of Frade, Frade Field, when we announced the deal with Inpex, which increased our stake from 52% to 70%. That provision will include to capture 70% for the decommissioning provision for Frade Field. It is important to remember that this provision for decommissioning is reviewed from time to time by ANP, considering market condition for decommissioning provision that existed in the past. With this, they consider very high prices for the drill ships. So these were all reviewed downward because of market conditions that is normal that this will be reviewed from time to time.

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Operator [16]

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This concludes today's question-and-answer session. I would like to turn the floor back to Mr. Nelson Tanure to proceed with the closing remarks. Please go ahead, sir.

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Nelson de Queiroz Sequeiros Tanure, Petro Rio S.A. - CEO & Director [17]

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Hello, everyone. Thank you very much for the questions and for your interest. We are very confident about the company. We are very excited, very optimistic, and we hope to continue to deliver very relevant results. Thank you very much.

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Operator [18]

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That does conclude PetroRio's conference call for today. Thank you very much for your participation, and have a good day.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]