Petroleo Brasileiro Petrobras SA (ADR) (PBR): A Slumbering Oil Giant Is About To Awaken

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Newly chastened by a collapse in its stock price, Petroleo Brasileiro Petrobras SA (ADR) (NYSE:PBR) is planning to sell up to $10 billion in assets this year. That target may prove conservative: “Potential sales of close to double the announced amount are possible, if all identified assets were actually able to be sold,” said Merrill Lynch’s analysts. That should help management keep a promise of avoiding further stock issuances.

Improving Financials

A combination of better cost controls, slowing capital spending and rising cash flow should set the stage for quickly improving debt ratios. For example, the interest coverage ratio is expected to rise 3 percentage points from 2012 through 2015.

Mitigated Currency Risk?
One of the challenges of investing in an ADR (American depositary receipt) like Petrobras is the currency risk. If the foreign currency weakens against the dollar, the ADR will drop in value by a commensurate amount.

That explains some of the poor performance of Petroleo Brasileiro Petrobras SA (ADR) (NYSE:PBR). In the summer of 2011, the U.S. dollar bought roughly 1.6 Brazilian reals. Yet the real has weakened so much that a dollar now buys 2.27 of them. In the past, that rapid devaluation caused pain for foreign investors, but the real now no longer carries the risk of overvaluation that it did a few years ago. In fact, when the Brazilian economy finds its footing and returns to its historical growth trajectory, the real should rebound, which would boost the performance of this ADR.

Risks to Consider: The biggest risk to this turnaround play is plunging oil prices. Crude oil has actually traded up in recent months, but a bigger slowdown in China or elsewhere could lead to a big drop in oil.

Action to Take –> Petroleo Brasileiro Petrobras SA (ADR) (NYSE:PBR) is an excellent case study in bad investment. Virtually every major move, both by management and the Brazilian government, has been to the detriment of shareholders. Yet with shares so deeply washed out, and management newly focused on improving returns, it’s time to forget the past and focus on what appears to be a still-bright future.

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This article was originally written by David Sterman and posted on StreetAuthority.

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