On Aug 19, 2013, we downgraded Brazilian state-run energy
giant Petroleo Brasileiro S.A., or
) to Underperform from Neutral.
Why the Downgrade?
Petrobras' erratic earnings trend have been a drag on its near to
medium term outlook. We also remain concerned by Petrobras' huge
investment requirements and the possibility of heightened state
Headquartered in Rio de Janeiro, Petrobras is the largest
integrated energy firm in Brazil. The company's activities
include: the exploration, exploitation and production of oil from
reservoir wells, shale and other rocks, and in the refining,
processing, trade and transport of oil and oil products, natural
gas and other fluid hydrocarbons, in addition to other
On Aug 12, Petrobras reported lower-than-expected June quarter
profits, owing to decreased liquids realizations and weak
production. Earnings per ADR came in at 46 cents, against the
Zacks Consensus Estimate of a profit of 51 cents. The company's
refining segment continues to bleed losses even after the recent
decision by the Brazilian government to allow it to raise diesel
and gasoline prices.
Petrobras has embarked on an ambitious investment program for the
2013-2017 period, totaling a massive $236.7 billion. This is
expected to substantially increase the company's leverage and
deteriorate its credit metrics during the current downturn in the
economic cycle. Additionally, the increasing capital intensity of
its operations may result in reduced returns going forward.
In Sep 2010, Petrobras raised R$120.4 billion ($70 billion) in
the biggest global share issue in history. Following the share
sale, the Brazilian government boosted its stake in Petrobras,
now controlling approximately 63% of the voting power. This has
led to investor skepticism regarding heightened state
interference in the company.
Finally, Petrobras' deep-sea pre-salt reserves include fields
that are located at water depths of more than 2,000 meters, and
then a further 5,000 meters below sand, rocks and salt - making
exploration technologically complex, challenging and expensive.
As such, the success of these projects remains uncertain and
bears a great financial risk.
Stocks That Warrant a Look
While we expect Petrobras to perform below its peers and industry
levels in the coming months and see little reason for investors
to own the stock, one can look at
Carrizo Oil & Gas Inc.
Abraxas Petroleum Corp.
Range Resources Corp.
) as good buying opportunities. These domestic upstream energy
operators - sporting a Zacks Rank #1 (Strong Buy) - have solid
secular growth stories with potential to rise significantly from
ABRAXAS PETE/NV (AXAS): Free Stock Analysis
CARRIZO OIL&GAS (CRZO): Free Stock Analysis
PETROBRAS-ADR C (PBR): Free Stock Analysis
RANGE RESOURCES (RRC): Free Stock Analysis
To read this article on Zacks.com click here.