We reiterate our Buy recommendation on PETBRA 7.875 ‘19s, 4.875 and 5.75‘20s, 5.375 ‘21s, ‘24s, ‘40s and 2115s, assign a Buy recommendation to thenewly-issued 8.375 ‘21s and a Hold recommendation to the 8.75 ‘26s, anddowngrade the 3.0 ‘19s, ‘23s, ‘41s and ‘44s to Hold from Buy and the 3.25 and3.5 ‘17s to Sell from Hold. Our rationale for the Buy recommendations include:(1) encouraging 1Q16 results (4.2x DB-adjusted run-rate net leverage despiteweak production, BRL and oil prices); (2) positive momentum on Brazil’smacro/governance front and on oil prices (likely to remain above USD40/bbl);and (3) still-wide risk-adjusted spreads relative to Brazil and EM peers. We haverevised our base-case forecasts (with a 2016 Brent price of USD43/bbl vs.

　　USD40/bbl previously, 2016 USDBRL of 3.7 vs. 3.8 previously and USD14bn ofasset sales through 2018 vs. 2019 previously) and now estimate net leverage(excluding non-cash EBITDA items) of 4.0x in 2016 (vs. 4.2x previously) and3.5x in 2020 (vs. 3.7x previously). We also forecast a cumulative funding gap(post this week’s issuance and excluding further asset sales) through March2020 of USD39bn (USD45bn previously) and USD2.5bn assuming USD13bn inadditional asset sales, 30% rollover of loan maturities and USD10bn of newloans from state-owned banks. Our favorite bonds in the PETBRA curve are the4.875 ‘20s due to their superior risk-adjusted value to Brazil and EM peers.

　　Solid 1Q16 results encourage us to expect better results ahead on higher oilprices, normalized production and well-anchored BRL. In our view, Petrobras’1Q16 results were quite encouraging, as the company managed to growEBITDA (adjusted to exclude non-cash items) sequentially by 8% (in USDterms) in a quarter that was impacted by production stoppages, weakdomestic demand, low oil prices (USD34/bbl Brent) and weak average USDBRL(3.9). The combination of a stronger BRL (3.56 spot and DB’s 3.7 YE forecast),higher oil prices (USD48.8/bbl Brent spot and USD48/bbl DB’s 2H16 forecast)and domestic oil and gas production normalization (to 2.5-2.6 Mboepd) bodeswell for future earnings and for our 4.0x 2016 net leverage forecast.

　　Stronger BRL/oil and a more market-friendly cabinet in Brazil point to fasterdeleveraging prospects for Petrobras, in our view. A string of dovish globalpolicy developments and Chinese stimuli earlier this year sparked a strong rallyin EM assets and commodities, including the BRL (Petrobras has negative USDexposure) and oil prices. Moreover, unplanned recent oil supply disruptions inNigeria, Canada and Libya have so far negated the impact of incremental oilproduction, thus supporting prices. These developments coincided withincreased prospects of a favorable government change in Brazil, furtherenhancing the valuation of Brazilian financial assets. The cabinet changecurrently taking place in Brazil following VP Michel Temer’s nomination by thecongress as Interim President (potentially becoming the official president ifPresident Dilma Rousseff’s impeachment is approved by the senate within 180days) has brought in some names well regarded by the market (includingHenrique Meirelles as finance minister and Ilan Goldfajn as central bank head),and we believe they have a good shot at reviving confidence in the economyand improving governance at state-owned companies, including Petrobras. Inour view, this could spark faster cost and capex cuts, faster asset sales and,along with a well-anchored BRL, faster deleveraging.

　　Key risks: In our view, the negative risks to Petrobras include negativeexposure to the USD (84% of the debt, ~50% of costs and capex, 35% ofrevenue), lower oil prices, political/macro challenges in Brazil, cash burn due toheavy capex, and a large debt maturity wall (USD73bn through 2020 andUSD101bn through 2024). Positive risks: higher oil prices, and stronger BRL.