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Barclays Belives in Brazil's Struggling Petrobras

Barclays Belives in Brazil's Struggling Petrobras

Posted by Laura Zúñiga on October 20, 2014

Barclays Capital is putting its money to work in Petrobras , the investment firm said in a note to clients Monday.

After meeting with Mauro Yuji, the executive in charge of Petrobras’ exploration and production, and planning manager Ted Helms in New York, Barclays oil analysts led by Paul Cheng reiterated the bank’s overweight call on the struggling Brazilian oil major.

Petrobras were down by over 6.06% on Monday as investors sell on a combination of lower oil prices and fraud investigations involving former high level staffers.

Cheng used Barclays’ favorite reason for investing in Petrobras: higher gasoline prices. The government has been hell bent on keeping gasoline prices low in order to curb inflation, but the market is banking on the new government to change that tack sooner rather than later.

“Despite the recent sharp fall of oil prices and the uncertainties surrounding the run off of the Brazil presidential election on October 26, we believe the risk/reward remains favorable and are buyers of the shares,” the analysts wrote. “Regardless of the outcome of the election, there is a window of 12-24 months after the election that the next administration could allow Petrobras to raise domestic product prices without risking too much political capital. If the incumbent remains in power, we think the first product price increase could come as early as November or December.”

The incumbent, Dilma Rousseff, is in a run for her life against Social Democrat Aécio Neves. Both are polling in a technical tie. Neves surprised everyone with a second place finish on Oct. 5, beating out who Barclays once expected to be the winner — Marina Silva. Silva placed a distant third. Now Neves will try to dethrone Dilma’s Workers’ Party, which has been at the helm of Brasilia since 2002.

Dilma allowed Petrobras to raise product prices five times between early 2012 and late 2013 before the Presidential election cycle kicked into the high gear. If Neves wins, the first increase could come as early as the first quarter, as he has also hinted at his willingness to raise consumer prices at the pump. Neves has said he wanted to raise gasoline taxes.

No matter who wins, the government’s primary objective is to control inflation and stimulate GDP growth by creating a reasonable business environment for Petrobras to operate in. This is very much an economy that has a historical fear of inflation. The ruling generation took power when inflation was over 500% a year.

Although Brazil’s equity market is one of the more diverse within emerging markets, Petrobras remains an important component of the Bovespa index. When Petrobras falls hard, so does the Ibovespa and that always pulls the rug out from under popular trades like the iShares MSCI Braizl (EWZ) exchange traded fund.

There has been some improvements at the corporate level, Barclays garnered from its sitdown with management last week.

According to Yuji, Petrobras has reduced drilling time by 11% per year since 2012 while lowering the completion time by 15% per year. Oil well productivity rates have been better than expected, the company reportedly said.

Petrobras’ development plan is based on the average initial peak production of 20 mb/d per day and an underlying decline rate of 10% annually compared to current average production of 21.3 mb/d per day and an underlying decline rate of only 3% annually over the last two years.

While rapidly falling oil prices have caused serious headwinds for other major drillers, Petrobras has remained relatively resilient, Barclays said.

According to management, Petrobras will not accelerate or decelerate any of its current projects in light of the recent changes in oil prices as the company is contracted largely through 2017. Management estimates that its full cycle break-even economics for its costly pre-salt operations are $54 a barrel with further room to improve this figure. Current oil prices are over $80.

Petrobras shares trade at a discount to American oil majors. It’s 2014 estimated price to earnings multiple is 10 times compared with U.S. integrated oil company averages estimated at 11.7 times. Petrobras has returned to paying high dividends. Current yield is 5.32%, while Toronto listed Suncor Energy pays a yield of 2.94% and Chevron pays 3.84% as of Monday.

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