(PBR) Petroleo Brasileiro S.A. Evenly Poised

We have maintained our Neutral recommendation on Brazilian state-run energy giant Petroleo Brasileiro S.A. (PBR), or Petrobras S.A. with a price target of $35.

We believe that continued demand growth in Brazil (expected to outperform developed countries in the next few years), together with all the new investments and acquisitions, will fuel Petrobras’ medium-term earnings outlook. Additionally, we expect the company to benefit from its expertise in deep-water operations, its recent major discoveries (that could double its resource base) and the growing domestic refined products market.

Petrobras’ know-how and proficiency in deep-water oil and gas exploration and production is reflected in its exceptional track record for hydrocarbon production growth, as well as prospects for production and reserves growth in the future, especially following significant offshore finds in the last few years. Recent discoveries include the Tupi field (discovered in 2006 and now renamed as Lula) with 5 – 8 billion barrels of recoverable reserves and the Lara field (discovered in 2008) with another 3 – 4 billion barrels, along with other finds like the Caramba field, the Carioca field and the Guara field.

However, we remain concerned with the significant increase in the level of its downstream investment in the face of a bearish refining margin outlook. Investor skepticism regarding the company’s huge investment requirements, as well as the possibility of heightened state interference and earnings dilution following the $70 billion share sale also remain near-term headwinds, in our view.

Additionally, 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.

Considering these factors, we see Petrobras ADRs performing in line with the broader market. Our long-term Neutral recommendation is supported by a Zacks #3 Rank (short-term Hold rating).

Headquartered in Rio de Janeiro, Petrobras competes with other established integrated energy firms like ExxonMobil Corp. (XOM), PetroChina Co. Ltd. (PTR), Royal Dutch Shell plc (RDSA), etc. The company’s activities include: exploration, exploitation and production of oil from reservoir wells, shale and other rocks, and refining, processing, trade and transport of oil and oil products, natural gas and other fluid hydrocarbons, in addition to other energy-related activities.

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