By Adam Fischbaum
Six months ago, I wrote an article profiling vertically integrated oiler ConocoPhillips (COP). One of Conoco's strengths is that its reserves are accessible in areas that Bill O'Grady of Confluence Asset Management refers to as "places where you'd want to raise children."
While ConocoPhillips is still one of my favorite equity ideas in the oil sector, I also see value in oil companies with reserves that lie in what O'Grady would consider "places where you wouldn't want to raise children."
A great name to look at in that space would be Total SA (TOT).
Paris-based Total SA, formerly Total Fina Elf SA, is one of the largest publicly-traded oil companies in the world, with a market cap of more than $124 billion and proven, recoverable reserves of more than 10 billion barrels. The company fits the classic definition of a fully-integrated oil company, carrying out everything from exploration and production (upstream operations) to the downstream operations of refining, marketing, trading and shipping of petroleum products.
The metrics propelling the stock are just plain cheap, and the dividend yield is flirting with 6%. It has huge market cap of $123 billion, so it's plenty stable. It also has good, cheap fundamentals, which I'll detail in a moment.
So what's the catch?
Remember the part about looking for oil in places where you wouldn't consider raising children?
The reward is worth the risk
Some of the countries where Total's reserves lie read like an itinerary for a U.N. Peace-Keeping unit: Angola, Congo, Yemen, Uganda, Nigeria... these are just a few of the countries where Total looks for oil. And while all countries have their beauty, there aren't many five-star ratings on Tripadvisor.com for these countries. In fact, well over 50% of Total's oil comes from either Africa or the Middle East. There's plenty of high-quality, easily accessible crude in these places. But there's also plenty of political instability, social unrest and corruption.
All this goes to say the $3.28 per share dividend shareholders are paid is well earned. And the company is committed to making sure shareholders are compensated for their risk.
As of September 2011, the company began paying the dividend on a quarterly basis. The major significance of this move is that it makes the dividend much more predictable. (Typically, foreign companies have different dividend schedules and policies than American firms. The dividend may be paid annually or maybe biannually.) The adoption of a quarterly dividend should attract more investors to the stock, thus supporting the price.
Total's management has also committed to sticking to a net debt-to-equity ratio of between 25% and 30%, while capping the dividend payout ratio at a targeted 50% of earnings. Keeping a close eye on the debt level and keeping the payout ratio at a modest level will ensure dividend safety.
Total's fundamentals will also ensure the viability of the dividend. The company reported revenue of $257 billion in 2011, beating last year's haul of $211 billion by a cool 21%. Earnings per share for the year also grew 16%, with $7.05 for 2011, compared with $6.08 in 2010.
Risks to Consider: Oil prices have been on a certifiable tear, with West Texas Intermediate crude climbing from around $85 in November of last year to more than $105 currently. Total's share price chart tracks the movement of oil prices as do the charts of the stocks of most other large oil companies. Just as prices go up, they can and will go down eventually. While one would think that lower oil prices would be better for an oil company (they are), the herd seldom sees that logic.
Be prepared for the price volatility that comes with one of the world's most crucial commodities. Total's generous dividend makes up for that risk. The company also faces more risk than most competitors due to the location of their assets. With the lion's share beneath the ground of the Middle East and Africa, the market will always discount the risk of the occasional terrorist explosion or military coup. Again, shareholders are compensated for this risk, and Total's history of operating strength demonstrates that the company has the ability to navigate this successfully.
At about $55 a share, Total trades with a forward P/E of 7.4 times projected 2012 earnings of $7.40 per share and pays out an annual dividend of $3.28 per share (a nearly 6% yield). Based on Total's large reserves and commitment to managing the company's debt load and dividend payout ratio, I'm comfortable with a 12-month price target of $66, facilitated by a 20% expansion of the forward P/E. That would translate into an approximate total return, including the dividend, of 26%. Good capital appreciation from a solid income stock.
Disclosure: Adam Fischbaum does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of COP in one or more if its “real money” portfolios.