Everybody loves an inspiring underdog story, but sometimes a comeback doesn't come.
The prolonged slump in commodity prices has taken a massive toll on Brazil's economic muscle, and mining and oil industry profit margins have shrunk to a thin trail, thanks to the tough trading environment. Two Brazilian giants are in all sorts of trouble.
At depressed prices, we ask, are these two companies true value plays and contrarian buys right now, or are they among a group of dangerous stocks that you should avoid? What is certain is that they're both part of a group of distressed and "Stressed Out" stocks that TheStreet will be monitoring through these choppy markets.PBR data by YCharts
Petrobras had a golden run for years -- and then came the oil price drop.
Oil and natural gas reserves for the state-run oil producer slipped 20% across 2015. The company cropped its output targets and considerably reduced its investment budgets for the near-term, in a bid to save more than $440 million or 1.8 billion Real, amid falling crude oil prices.
And this is just the beginning of the rot. Beyond the financial challenges or the price fluctuations, Petrobras's fate is more complex and alarmingly darker.
What's particularly worrying is the corruption scandal that's rocked the company and ensnared some of Brazil's highest-ranking politicians. Norway's $800 billion sovereign wealth fund (the largest in the world) has already put Petrobras on its list for potential divestment, in lieu of the escalating corruption risks. Battling these charges and striving to clear their name will take the management a considerable amount of time.
Meanwhile, the company's employees are restive. With a large employee base and dwindling production assets (compared to global peers like Norway's Statoil ASA), major cuts have been announced. Further layoffs are in the offing.
And even as oil prices are moving in the direction of $20 a barrel, Petrobras may find many of its projects to be unviable. While this may not be an absolute death rattle, all of this makes stock markets edgy and uncertain, fostering chaos.
The stock (which doesn't pay dividends), after slumping by 41.10% in 2015, is now down 19.30% in 2016 so far.
While the stock is priced at an attractive 13.35 times forward price to earnings, adjusting for growth there's actually little value. At a price-to-earnings growth (PEG) ratio of over 16.18 (since five-year forward growth is less than 1% a year), Petrobras is highly over-valued (compared to the industry's 3.67 and the S&P 500's 1.68).
And finally, we don't see any silver lining in the future. Goldman Sachs Group has suggested that the crisis in Brazil will get worse before it gets better.
With a levered negative cash flow of $2.74 billion, total debt/equity ratio at 174.10 times (thanks to a total debt of $124.29 billion and negative profit margins), Petrobras is rated junk by three major credit rating companies. This rating firmly puts this stock in a category of terrible investments that you should avoid at all costs.
One of the highest dividend payers in the sector and the world's leading producer of iron ore and nickel, Vale is going through tough times. The mining giant's executive board has proposed a zero dividend this year to its supervisory board.
Waning demand from China has meant that producers like Vale are gutted. The company's high leverage to China helped it become the world's largest iron ore miner, but China is now quickly turning into a curse that Vale would like to get rid of, but simply can't.
While Vale's dividend cut is bad news, others have also resorted to similar moves: Anglo American plc and Glencore plc have also gone down this same road.
Vale has attempted to manage its costs, but there are several challenges it must address. The company must share the repair costs of November's deadly dam breach at its joint venture with BHP Billiton Ltd. as well as finish the iron-ore industry's biggest project (S11D).
If the company loses its investment-grade status, debt costs are sure to pile up further.
Also keep in mind, that a rebound in commodity prices is rather unlikely in the foreseeable future -- at least not one strong enough to steady Vale's rocking boat. The World Bank has already projected iron ore to log the biggest loss among metals for 2016.
As far as earnings go, analysts are penciling in losses for both the Dec. 2015 and Dec. 2016 years, with a decline in sales. A company with a nearly 6% drop in earnings every year for the next five years is not a fit case for investment.
We believe Vale will divest noncore assets to finance its large capital expenditure plans and finally perhaps cut that budget as well -- and in a big way.
As you can see, the two companies examined above are stressed out stocks that are poised for collapse. However, if you want to see a list of the absolute worst stocks you can own right now, I urge you to download this free report. Inside, you'll see a full list of the market's most overvalued stocks, and learn the process you can use to keep avoiding them in the future. Click here now for a copy.