Why Merrill Lynch Raised Petrobras Argentina and YPF

The first thing that Merrill Lynch spelled out in its report was that this was not the Petrobras most investors think of, the one in Brazil. Still, one has to wonder what could happen if sentiment were to ever change there as well. Here is what the Merrill Lynch team sees for Argentina.

On the broad scope, it is likely that volatility will remain high over the next year due to a tumultuous period in advance of and following the presidential election in October 2015. With persistently high inflation, an overvalued currency and softening economy, the near-term outlook for prices and costs in dollar terms is considered difficult to predict.

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The general expectation from the coming election is that any new president is likely to face a very difficult economic environment. This could lead to a long-term adjustment in key factors that affect Petrobras Argentina’s profitability, including:

• A possible foreign exchange (FX) devaluation
• An adjustment to energy tariffs, which could hurt consumer disposable income
• Anti-inflation program
• An elimination of FX controls to make it easier to attract capital into Argentina

Petrobras Argentina was raised to Buy from Underperform at Merrill Lynch, and analysts raised the price target to $9 from $5. The company’s growth in coming years is expected to be mostly focused on tight gas projects, with important upside over the next several years in the Punta Rosada development in the Rio Neuquén area. These are expected to contribute to a 20% increase in gas output at the company over the next five to 10 years.

At this point, the stock is at a relatively low value, but with the upcoming elections and political change, the Argentine country risk could be positive for Petrobras Argentina over the next 12 months.

Shares of Petrobras Argentina were up 4.2% at $6.62 at midday in Monday’s trading session. The stock has a consensus analyst price target of $5.00 and a 52-week trading range of $4.32 to $7.40.

Merrill Lynch also upgraded YPF to a Buy rating from Underperform and raised the price target to $39 from $26 per American depositary share. The potential changes in Argentina’s economic policy would help to lower the level of Argentine risk embedded in the equity and potentially contribute to an important rise in the share price. YPF is currently Merrill Lynch’s top pick in Latin American oil and gas.

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YPF is similar to Petrobras Argentina in terms of having a strong upside potential from conventional and tight gas projects. YPF sees more upside potential from full development of Argentina’s shale resources, but in the analyst’s opinion, this would require improvement in oil prices and a reduction in unit costs.

YPF shares were up 0.7% at $26.91, in a 52-week trading range of $20.83 to $41.74. The consensus price target is $36.18.