Repsol YPF Downgraded

We have recently downgraded Repsol YPF S.A. (REP: 24.21 +0.89 +3.82%) ADRs to Underperform from Neutral. We see little reason for investors to hold Repsol, as we believe that the long list of challenges facing the company will further weigh on its valuation. These include weak reserves, low reserve lives and poor refining margins.
 
While the company's production volumes are increasing, refining margins were significantly lower during the last year, especially in the fourth quarter, dropping more than 80% as a result of narrower spreads on crude oil and oil products due to supply and demand forces. We believe that this imbalance between supply and demand will remain in place in the near term and negatively impact the bottom line.
 
Though Repsol's reserve replacement ratio showed signs of improvement (94% in 2009 vs. 65% in 2008), it is one of the lowest in the entire group. Repsol's reserve replacement track record is also one of the weakest in its peer group, with proved reserves declining 8% each during 2007 and 2008. 

Although this year's Argentine plan could boost its development of reserves, these may not be able to adequately replenish the poor reserves position due to rate imbalance between production and new discovery. 

While success on the exploration front and strategic moves to reduce its Argentine exposure are welcome steps, fairly little has changed with respect to Repsol's overall long-term visibility. Since the beginning of this year, price of Repsol ADRs has gone down more than 14% to $23.32 at yesterday's closing.