PRIO (PRIO3) becomes Morgan’s top pick and has a target price raised by another “bank”

In a report, Morgan Stanley elected PRIO (PRIO3) as Morgan Stanley’s main choice in the Brazilian oil and gas sector, with a recommendation overweight (exposure above the market average, equivalent to purchase) maintained and target price reduced from R$66 to R$65.

The American bank explains that despite the delay in Wahoo’s first oil and recent excess production, the stock still offers a robust free cash flow (FCF) return and a differentiated option in new mergers and acquisitions (M&A) or a dividend attractive.

JPMorgan analysts point out that Wahoo’s drilling license remains a point of discussion, as Ibama has been on strike since the beginning of January, which prevents PRIO from starting the process on the four development wells at Wahoo. “With limited availability of pipeline support vessels across the industry (required to connect wells to the mooring structure), the original estimate of first oil for August now appears unrealistic,” they assess.

According to the report, a delay caused by external factors, such as a prolonged Ibama strike, is beyond the company’s control and should not be seen as an execution failure. But inevitably, this may have triggered negative short-term earnings revisions as first oil is delayed until closer to the end of the year.

Based on the delay, Morgan now expects first oil in December with two wells, followed by two more in January and February 2025. While the impact on Wahoo’s 2024 production will be substantial (about 20,000 barrels per day) to 2 thousand barrels per day), the 2025 figures are only slightly affected (from around 40 thousand barrels per day to 37 thousand barrels per day). Most importantly, in the bank’s assessment, the impact on the net value (NAV) of a six-month delay is very small, around R$1.00 per share, or 2.0% of the current share price.

Given this, the bank sees PRIO generating a free cash flow return of 16% in 2024 and 27% in 2025, which is attractive, given the lower risk of project execution compared to peers.

Over the past three quarters, FCF generation has averaged about $250 million, a figure the bank expects to rise to about $550 million per quarter once Wahoo reaches full capacity in mid-2025. which will give management flexibility to pursue acquisitions or pay dividends and share repurchases.

With a conservative oil price of US$70 per barrel, according to Morgan Stanley calculations, PRIO would have firepower of around US$5.1 billion for acquisitions and dividends, assuming a Net Debt/EBITDA ceiling of 1 .5 times.

JPMorgan, in turn, maintained a recommendation equivalent to purchase for PRIO shares and raised the target price from R$65 to R$70, incorporating its expectations for the results of the first quarter of 2024 and including Wahoo’s total participation in the oil company model.

For analysts, PRIO presents an interesting growth perspective with the launch of the second phase of recovery at Frade, drilling at Wahoo and the closure of Albacora Leste. “The company effectively incorporated the Polvo, Tubarão Martelo and Frade fields, applying cost efficiency measures and a strategy focused on asset recovery”, they comment. In this sense, they believe that PRIO should repeat its success in developing the Albacora Leste and Wahoo fields.

In terms of valuation, JPMorgan sees the oil company’s share trading at 4.1 times Firm Value (EV)/Ebitda in 2024.

Regarding risks, the bank cites operational risk and diversification, as the oil company has smaller production than large companies and fewer fields on which this production is based. “In this way, any setback with the assets (in terms of production, environmental risks, among others) in the portfolio could represent negative risks for the evaluation”, he explains.

Furthermore, analysts cite that a change in the fiscal framework could weigh on the company’s return, implying negative risks for the bank’s estimates.

Finally, JPMorgan comments that PRIO obtains all of its revenue from the sale of oil and gas, and, as such, any variation in gas and Brent prices could affect the company’s results. The oil company also has the majority of its cash and debt denominated in dollars, which could bring volatility to the company’s results, depending on its financial position.