Total (NYSE:TOT), the third biggest European oil company, has underperformed the wider European oil sector [SEXP] in the last three and six months. While the Russian-Ukrainian crisis, which negatively impacted Total's stake in Novatek, has a role to play in this underperformance, I think the weak cash flow numbers reported in the first half of 2014 played a bigger role in this poor stock performance.
Two of the key points of Total's 2015 guidance (2.6 MBOE/d production and free cash flow of $10 billion) are still outstanding and imply an underlying cash flow aspiration of $35 billion. So far adjusted cash flow from operations (1H14 annualized) falls about 30% short of this target and it looks highly unlikely that the company will be able to achieve its ambitious targets for 2015. However, this is not a surprise and in my opinion these targets are not reflected in market expectations either. Total will hold its annual investor day in September and I expect the French oil giant to revise down its targets at its investor day.
Total reported 2Q14 adjusted net income of $3.15 billion, which came in slightly below the consensus estimates of $3.2 billion. Without going into details, it looked like all business segments reported strong results other than Corporate, which dragged the results down by $436 million. However, the details reveal a few weak points in the underlying results. Upstream benefited from a low tax due to a one-off tax adjustment and the Corporate line included a ~$200 million write-off of NOLs (non-cash) generated in France which will become a recurring charge for the medium term.
2Q14 Represents The Low Point For Total
I think the recent underperformance in TOT's shares provides an opportunity to revisit Total. I think it is not a time to worry instead it is a time to be optimistic. Total is set to see a large pipeline of upstream start-ups (at least 10 new projects), which combined with the planned reduction in capex and restructuring of the downstream segment will underpin arguably one of the largest inflection in FCF amongst European oil majors. As the new projects come online and capex comes down, momentum in both cash flow and production should build throughout the rest of 2014 and 2015 and in turn should help share price performance.
All the new projects planned for launch in 2014 and 2015 are progressing well. Of the 10 projects, only the CLOV field in Angola has started production, but made essentially no contribution to 2Q14 production, as it started only in June. CLOV is currently producing at ~80,000 BOE/d and is scheduled to reach the 160,000 BOE/d plateau in the next couple of months and at plateau will generate $1.5 billion in cash flow on an annual basis. Three other projects are expected to start in 2014 and an additional six in 2015. This means that 2Q14 represent the low point for TOT both in terms of production and cash flow.
Upstream start-ups and ramps between 2014 and 2017 are likely to add $7.8 billion (Morgan Stanley estimates) in operational cash flow net of decline in the mature part of the portfolio. In addition, some cash flow growth is also likely in the downstream business, as the third biggest European oil company brings the Jubail refinery on-stream and targets cost savings across those businesses.
Transition To A Better Phase
2012-2014 has previously been described by the French company as a period of transition to a better phase (2015-17). In this period of transition, high capex exceeded organic cash flow and limited production growth before the start-up of new projects. While 2014 was never meant to see all of Total's problems resolved, with a number of new projects coming online in the next one and a half year and capex declining, the company should see a considerable improvement in free cash flow.
The company is also on track to reach $15-$20 billion asset sale target. TOT has already completed $14.5 billion worth of divestments and has announced an additional $2.5 billion that is currently pending (Shah Deniz, South African coal mines, GTT, and CCP Composites). While the sudden cancellation of the $2.5 billion sale of Usan project in Nigeria to Sinopec was disappointing, the company is already looking for a new buyer.
I believe 2Q14 was the low point for Total both in terms of cash flow and production, and the European giant is all set to show significant growth in cash flow and production in the coming years. These factors combined with declining capex should provide a rapid return to cash flow neutrality. While the share price may see some weakness in the near-term, driven my macroeconomic factors and geopolitical risks, the prospects for strong FCF over the next few years remain strong. Meanwhile, the company continues to offer high dividend yield of 5.0%.
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