Why JPMorgan Just Upgraded Petrobras

In a report published Monday, JPMorgan analysts Marcos Severine and Felipe Santos upgraded their rating on shares of Petroleo Brasileiro Petrobras SA (ADR) (NYSE: PBR) from Neutral to Overweight, fixing a price target of $10.50 (BRL18/sh for PETR4 and PETR3) for next year.

The experts continue to see this as a deleveraging story, “mostly dependent on Brent prices and FX rate.”

They believe a “more constructive and pragmatic approach” would be best in this case, as the company’s controlling shareholder  -- the Brazilian government -- wants to improve investors' perception of Petrobras.

An alarmingly high debt-to-equity ratio combined with recurrently weak cash flow generation capabilities up to 2021 turns this investment into a very challenging one, “with little room for mismanagement practices or political interference,” the analysts explained.

Related Link: Tudor, Pickering, Holt & Co: Buy Petrobras, It's Worth $15/ADR

Despite the fact that Severine and Santos think “the definition and disclosure of a pricing formula for downstream is unlikely to take place in the ongoing administration,” they feel confident about the government wanting to avoid substantial losses in refining. They consider this essential in order for the company to avoid a credit downgrade.

"Maintaining a positive EBITDA margin on downstream along with a more conservative capex plan are key to deleverage PBR," the note said.

Bottom line, the firm classified Petrobras as a de-risking story, which can drive share prices up going forward.