What happened
Shares of Brazilian oil company Petroleo Brasileiro (PBR +2.07%) (PBR.A +1.39%) slipped somewhat this morning after investment bank UBS flipped 180 degrees from buy to sell on the oil stock.
The amount of the decline is in some dispute, with Google Finance clocking an 18% fall on PBR shares from a closing price of $11.40 per share last night, while Yahoo! Finance says it closed at only $10.10 per share and is down only 4%. The truth may be somewhere in the middle. Stock broker Fidelity says the last price it saw Petrobras shares traded at last night was $10.75 per share.
With Petrobras selling at $9.70 per share as of 10:10 a.m. ET -- a figure on which all sources agree -- that still works out to a disheartening 4% decline in its share price this morning.
NYSE: PBR
Key Data Points
So what
Also undisputed is the reason Petrobras shares are falling: the downgrade.
As The Fly reports, UBS cut its valuation on Petrobras by more than half, from 47 Brazilian reais ($8.78) to R$22, warning that the company will "switch" its direction under Brazil's leftist president-elect, Luiz Inácio Lula da Silva. UBS warns that, instead of paying down debt and paying out dividends to its shareholders over the next four to eight years, Petrobras is likely to increase capital spending to expand production and sacrifice profit margins by lowering fuel prices for Brazilian consumers.
The likely effect on profits, says UBS, makes the banker "substantially more cautious" about investing in the stock.
Now what
Should you be cautious, too?
On the surface, Petrobras stock looks a bit too good to be true right now. According to data from S&P Global Market Intelligence, Petrobras paid out $2.50 per share in dividends over the past year, which works out to a dividend yield of 25%.
That sounds pretty great ... unless UBS is right about the risk that this dividend will get slashed.
Petrobras also earned more than $33 billion on a market capitalization of barely $70 billion -- a P/E ratio of just 2.1. That's a lot of profit for such a small market cap ... unless UBS is right about the risk that profits are about to plummet.
To top it all off, Petrobras generated positive free cash flow even higher than its reported profits -- nearly $37 billion. That's a lot of cash Petrobras is generating ... unless it's about to become a lot less cash.
UBS is right that a lot could go wrong with Petrobras. It's important not to understate the risks. That being said, this stock looks so cheap right now that even if Petrobras suffers a steep decline in profitability and reduces its dividend significantly, there's still a good chance this stock could end up a bargain.
My best advice: Wait and see what Petrobras actually does. See what the valuation looks like then, before deciding whether to invest in it.
