Petrobras Downgrade: Fundamentals Outpace Management

• Petroleo Brasileiro Petrobras SA (ADR) PBR shares are down 35 percent year-to-date, not reaching a double-digit price after May.
• JP Morgan’s Marcos M. Severine downgraded the rating for the company from Overweight to Neutral, while reducing the price target from $10.5 back to $7.
• Although the company’s management has taken several steps to deleverage the company, Severine believes that the deteriorating macroeconomic environment calls for a downgrade.

Analyst Marcos M. Severine wrote that the combination of deterioration in Brazil’s political scenario and macroeconomic environment as well as the high volatility in Brent prices and currency related risks call for the downgrade in rating.

The challenging macro environment also includes the company’s IG rating being downgraded by both Moody’s and S&P, which led Petrobras to become “a High Yield company, with implications on the debt and equity side.”

Saying that the Brent prices are expected to rise to $60/bbl and BRL/USD depreciation is estimated to reach 26 percent y/y, Severine added that, in the short term, an increase in fuel prices is among the “few actions the management can take to avoid a sizeable cash burn.”

Severine further expects the company’s shares to reflect an “increased risk perception” towards Brazil and for the cost of debt to increase as expected. Lending costs are likely to increase, reflecting the loss of the IG rating by Moody’s and S&P. The company will need to meet its cash needs by taking Chinese bank loans or with asset sales, the JP Morgan report stated.

“PBR’s management has been taking actions toward deleveraging the company, such as cutting capex and reducing costs focusing on maximizing the company’s cash usage,” Severine noted.

Given the faster-than-anticipated weakening of the Brazilian macroeconomic situation and the double loss of IG rating by the company, Severine believes a Neutral rating “better reflects” the company’s current risk/reward profile.