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

Less than a decade ago, Petroleo Brasileiro Petrobras SA (ADR) (NYSE:PBR) was the hottest oil company on the planet. A massive offshore discovery led the residents of Sao Paolo and Rio de Janeiro to dance in the streets, looking ahead to the day when all that oil money would circulate through the economy.

Yet year after year, Petroleo Brasileiro Petrobras SA (ADR) (NYSE:PBR) has managed to disappoint its backers in new and novel ways. The oil giant vastly overspent to get those big oil fields ready for production, the Brazilian government sought onerous levels of taxesfrom the company, and investors had to sit idly by as the company issued massive blocks of new shares, leading to hefty dilution.

Just how badly did things turn out? Back in 2007, before Petroleo Brasileiro Petrobras SA (ADR) (NYSE:PBR) began the heavy lifting to start production on its major new oil fields, the company had 23% operating margins and earnings per share of around $3. By 2012, those two figures had fallen by half. At this point, most investors have simply abandoned ship. Yet it’s time to give this broken stock a fresh look.

The Looming Payoff
Although Petroleo Brasileiro Petrobras SA (ADR) (NYSE:PBR) has clearly dropped the ball repeatedly over the past five years, a lot of foundation-building is set to pay off — but not quite yet. Petrobras will probably deliver another set of weak financial results when quarterly results are released later this month, thanks to heavy spending on equipment maintenance and still-constrained output.

Yet that may mark the end of the era of reckless spending. In a March 2013 meeting with analysts, Petroleo Brasileiro Petrobras SA (ADR) (NYSE:PBR)’ management, according to Merrill Lynch analysts, “indicated it is very focused on reducing costs over the next few years to improve financial returns. It suggested that this is the first time a serious cost-cutting program has been introduced at the company.”

The wind down in spending should coincide with a long-awaited upturn in production as “pre-development” oil fields finally come online. It will be a slow ramp in the first few quarters, based on current production schedule, but starting with the first quarter of 2014, output should accelerate more quickly, leading analyst to expect Petrobras to have one of the highest growth rates in the industry for the next five years.

A Cleaner Balance Sheet
One of the key drags on this stock has been a debt-laden balance sheet. Total debt, which stood at $69 billion at the end of 2010, swelled to $96 billion by the end of 2012. Management simply became too aggressive in its pursuit of oil and gas fields throughout Latin American and elsewhere.

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