Why Total Is Likely To Continue Outperforming Exxon And Chevron

Mar. 5.14 | About: TOTAL S.A. (TOT)

Summary

While capital expenses have greatly escalated for the oil companies in the last few years, Total seems to be better positioned than Exxon and Chevron.

As Total provides detailed figures for its projected 30% increase in oil production by 2017 and its recent record is on track, it is likely to accomplish its goal.

Based on Total's projection, we calculated that its earnings per share will increase by about 30% in 2017, which means a compounded annual return of 12% till 2017.

Given the above and the great difficulties Exxon and Chevron are having in replenishing their oil reserves, Total is likely to continue outperforming Exxon and Chevron.

Total S.A. (NYSE:TOT) has consistently and pronouncedly underperformed Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX) during the last decade. The most prevalent reason for its underperformance has been its markedly inferior performance in its earnings growth. To be sure, Total grew its earnings per share (EPS) only 35% in the last decade, whereas Exxon and Chevron achieved an EPS growth of 86% and 79%, respectively. This was reflected in the performance of the stock prices in the last decade, with Total markedly lagging versus Exxon and Chevron (40% vs. 130% and 155%, respectively).

However, in the last 12 months, Total has greatly outperformed its peers, with its stock price advancing 30%, while Exxon advanced only 9% and Chevron remained constant. Total has a similar P/E to Chevron (10.1 and 10.5, respectively), much lower than the P/E=13 of Exxon, which is high for oil companies. The valuation of Exxon was somewhat enhanced when the company reported an increase in its production volume in its Q3 results after many disappointing quarters in a row and received an additional boost when Buffett revealed his stake in the company. Nevertheless, the big question is why the relative performance of the above 3 stocks has changed so dramatically and whether Total will continue to outperform.

Note: Investors should pay great attention in the metrics of Total, as some financial sites (e.g. finance.yahoo.com) have some figures in Euros and hence they incorrectly calculate the P/E and other ratios.

Upstream vs. downstream

The refining sector has been facing a uniquely tough period in the last 5 years, with continuously declining margins. The reason for this is the emergence of ample new refining capacity in the Asia-Pacific area, which has greatly depressed the global refinery margins. More specifically, 8.5 M barrels per day refining capacity was added during 2009-2012, which corresponded to a 10% increase of global capacity, with about half in the Asia-Pacific region.

As it takes about 5 years from the investment decision to the start-up of a new refinery, the new refineries were established thanks to the "golden" refinery years 2004-2006. Hence the excess capacity has now led the global refining margins to record-low levels, resulting in the closure of about 30 refineries in 2009-2012, mostly in Europe and Japan. That's why all the oil majors have been selling their downstream assets in the last few years in favor of some new upstream projects.

Total, Exxon and Chevron have been earning the major portion of their net income from the upstream sector. To be sure, Total has been earning on average 80% of its earnings from the upstream sector in the last 6 years. The relevant figure is the same for Exxon and 90% for Chevron. Therefore, as the refining margins are expected to remain suppressed in the years ahead, the main determinant of the earnings of these companies and all the other oil majors is their performance in the upstream sector.

Product mix of the upstream sector

As oil has enjoyed a much higher price than gas in the last 5 years, the companies that produce more liquids than gases have enjoyed a great tailwind. Having said that, it is remarkably unfortunate for Total that it has steadily shifted from a ratio of oil/gas 62/38 in 2008 to a 51/49 mix in 2013:

2008

2009

2010

2011

2012

2013

Liquid production

62%

61%

56%

57%

53%

51%

Gas production

38%

39%

44%

43%

47%

49%

Click to enlarge

Exxon Mobil has been affected in its performance by the same 50/50 ratio of oil to gases, while Chevron is more oriented towards liquids, with a 65/35 ratio. The persistently low price of gas has been a headwind for many years for Total and Exxon and is expected to remain as such in the next few years, thanks to the new drilling techniques (horizontal drilling and fracturing) that have greatly facilitated the production of natural gas. Therefore, Chevron possesses a superior product mix, which does not explain its cheap valuation compared to Exxon.

Capital expenses and owner's earnings

As I analyzed in a previous article, the oil companies have been striving harder every year in order to replenish their reserves and hence they have been facing extremely high capital expenses. As the table shows, the capital expenses of Total have grown by about 50% in the last 5 years, while they have approximately doubled for Exxon and Chevron.

According to Buffett, the real owner's earnings are the reported earnings plus the depreciation minus the capital expenses required to maintain constant sales (not the capital expenses used for growth). Unfortunately, the oil production of most oil companies (including Total, Exxon and Chevron) has remained almost constant in the last few years so the above formula can be applied to calculate the real owner's earnings of these 3 companies. The results are presented in the table below.

TOT

2008

2009

2010

2011

2012

2013

Net income ($B)

20,533

10,610

14,080

17,071

17,153

15,838

Depreciation ($B)

8,465

9,320

11,164

10,448

12,237

11,994

Capex ($B)

16,260

14,322

15,851

22,220

21,933

25,881

Owner's earnings ($B)

12,738

5,608

93,93

52,99

7,457

1,951

% decrease in earnings

38%

47%

33%

69%

57%

88%

XOM

Net income ($B)

46,867

19,658

31,398

42,206

47,681

32,580

Depreciation ($B)

12,379

11,917

14,760

15,583

15,888

17,197

Capex ($B)

19,318

22,491

32,226

36,766

39,799

42,489

Owner's earnings ($B)

39,928

9,084

13,932

21,023

23,770

7,288

% decrease in earnings

15%

54%

56%

50%

50%

78%

Click to enlarge

CVX

Net income ($B)

24,031

10,563

19,136

27,008

26,336

21,423

Depreciation ($B)

9,528

12,110

13,063

12,911

13,413

14,186

Capex ($B)

22,775

22,737

21,755

29,066

34,229

41,877

Owner's earnings ($B)

10,784

-64

10,444

10,853

5,520

-6,268

% decrease in earnings

55%

101%

45%

60%

79%

129%

Click to enlarge

On average the real earnings of Total, Exxon and Chevron are 55%, 50% and 78%, respectively, below their reported earnings. This is actually the reason for the persistently low P/E of the oil companies, compared to the market. But more importantly, Total and Exxon seem to be in a much better position than Chevron in this metric. To be sure, not only Chevron has the lowest real earnings, as compared to the reported earnings, but it is also the only company that had negative real earnings last year; which are expected to remain negative this year based on the capex outlook of the company ($40 B for 2014). The real earnings certainly justify, at least in part, the low valuation of Chevron (P/E=10.5) vs. Exxon (P/E=13).

It should be noted that the capital expenses that have already been realized are likely to eventually result in some growth in future income so the picture for the oil companies is not as pessimistic as described above.

Production growth

Although it is really hard to predict the future sales of most companies, it is much simpler to predict the sales volume of the oil majors; they will sell as much as they will be able to produce, as long as the oil price does not experience a major shift (OPEC quotas have a minor effect in most years and definitely in the long run). Therefore, one can study the production outlook provided by each company in order to predict the future sales.

However, the managements of most oil companies have repeatedly failed to live up to their own projections, as it has become increasingly hard to replenish their oil reserves. Therefore, it is important to check whether each management has fulfilled its past promises or it keeps promising untouchable goals. To this end, I examined whether each company achieved the production target that was set in a previous annual report. The table below shows the upstream production per year of each company in Kbbl/day:

2008

2009

2010

2011

2012

2013

Total

2,341

2,281

2,378

2,146

2,300

2,299

Exxon

3,921

3,932

4,447

4,506

4,239

4,175

Chevron

2,530

2,704

2,763

2,673

2,610

2,597

Click to enlarge

According to the annual report of Total in 2011, the upstream production of Total should have grown by 2.5% annually since 2011. Indeed, its production increased about 7% from 2011 to 2013 so the management has kept its word so far. The only worrying aspect is that the production declined by 2% from 2008 to 2013.

As per its last earnings report, the company is expected to achieve an exceptional 30% growth in its upstream production from 2,300 to 3,000 Kbbl/day in the next 4 years. Although this may seem highly optimistic, the recent accomplishment of the previous targets and the not-too-long-time horizon indicate that the company is likely to achieve its goal. To be sure, the list of the new fields coming into play in 2014-2017 indeed offset the annual decline 3%-4% of the old fields by more than 700,000 bbl/day so the management seems credible.

In order to calculate the contribution of the increased production on the net income of the company, it is obvious that the net income in 2017 will depend on the prevailing oil prices. Under the oil prices that have prevailed in the last 3 years (90-110 $/bbl), the average net income of the company has been about 18 $/bbl. Therefore, we can calculate that the new production will raise the net income by about $4.6 B in 2017 (=0.7*365*18), which means approximate EPS=8.2 or 30% increase from last year.

In contrast to Total, Exxon did not provide any projection for its future output in its reports and presentations at the year end. The management only mentioned that there are numerous new oil fields that will come into play until 2017. However, it did not specify by what margin they are expected to outweigh the natural decline of the old fields.

Even worse, as shown in the table above, the upstream production of Exxon declined by 6% from 2010 to 2013. One should not be misled by the great hike in output in 2010, as that was the year of the acquisition of XTO. That acquisition may have greatly raised the total output but it was executed at an elevated price (because the price of natural gas was extreme when the deal was closed) and also shifted the oil/gas ratio of Exxon from 60/40 to the more unfavorable 50/50 ratio.

Like Exxon, Chevron missed its own forecast last year. In its annual report of 2012, the management predicted a production rate of 2,650 Kbbl/day but the real figure turned out to be 2% lower, at 2,597 Kbbl/day. The same occurred in 2011, when the upstream output of the company fell 3% even though the management had predicted a 1% increase in its annual report. Moreover, the upstream production has declined by 4% in the last 4 years. These facts seem to have disappointed the market, leading the stock to a really cheap valuation (P/E=10.5) while the market is at its all-time highs.

Chevron has emphasized its outlook for a 27% increase in its upstream production from 2,600 in 2013 to 3,300 Kbbl/day in 2017. However, the management has not provided estimates for the production capacity of its expected new fields. Therefore, given the disappointing production figures of the last few years as well, there are some big question marks whether the management will manage to reach its goal. Of course, Chevron has a great past record (before recent years) and a very competent management so it deserves the benefit of the doubt but the truth is that the exploration of new oil fields has become much more difficult and costly in the recent years. To be sure, last year was the first time that Chevron experienced real losses, as described above.

Hopefully, the major upstream projects that have caused record-high capital expenses will help the company reach its goal in 2017. However, in the meantime, the market will need to witness some real progress in the production volume to reward the stock price.

Sensitivity analysis for Total

The price of crude oil and natural gas are the major determinants of the net income of the major oil companies. The price of Brent has consolidated in the range $90-$110 in the last 3 years and, despite its unpredictable nature, it is expected to continue trading around this range in the next few years. In any case, the best price we can use in our calculations is last year's average price.

As described above, the EPS of Total are expected to rise from 6.3 in 2013 to about 8.2 in 2017. Total is the only one of the 3 companies that provides sensitivity figures for the dependence of its net income on the price of Brent. More specifically, its net income increases by about $112 M for every $1 increase in Brent.

Based on these numbers, one can calculate the EPS (in $/share) of Total in 2017 for a range of prices of Brent ($99-$119). The base scenario (EPS=8.2) is the one that corresponds to the average price of Brent in 2013 (109 $/bbl).

Oil price 99 104 109 114 119
EPS 7.9 8.1 8.2 8.4 8.6
Click to enlarge

Conclusively, the recent pronounced outperformance of Total should not mislead investors, as it has only served to raise the stock from an extremely low valuation a year ago (P/E=7) to a more reasonable valuation now (P/E=10). As Exxon and Chevron seem to be in a much more uncertain status and Total seems to be better positioned at the crucial field of upstream growth, Total has a high chance of continuing to outperform Exxon and Chevron by up to 20%-30% in the next few months or years.The results show that the EPS of Total in 2017 will be in the range 7.9-8.6 if the company meets its production outlook and the price of Brent does not change dramatically. As per the base scenario (EPS=8.2) and assuming (pessimistically) that the P/E ratio of Total will remain at its current depressed level (10.1), the stock of Total will yield capital gains of about 30% till 2017. Moreover, it will also be offering an approximate 5% dividend yield every year. Therefore, Total is expected to achieve a compounded annual yield of about 12% till 2017, which is really attractive given the headwinds of the oil companies and the fact that the market is at its all-time highs.

Disclosure: I am long CVX, TOT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.