If French integrated oil company Total SA (NYSE:TOT) can do what management says it can, this could be one of the better-performing energy majors over the next five years, even with a strong 50% run over the past year that is second only to Statoil (NYSE:STO), among the majors. The catch there is that what management is looking to do is not going to be easy - post one of the best five-year production rates while reducing capex, execute on multiple high-risk projects, and turn the downstream operations around so as to generate double-digit returns on capital. Although I'm not as bullish on Total's prospects as its management team, I do nevertheless think this is one of the more attractive European majors today.
Total SA, In Brief
Total SA is one of the largest publicly-owned oil companies in the world, ranking sixth in reserves and seventh in production. Total is also a top-10 chemicals company and the largest refiner in Europe. Like most integrated oil companies, Total generates the large majority of its profits (80%-plus) from its upstream operations.
Total produced 2.3 million boe per day in 2013, with about 10% of that coming from deepwater assets and 20% from assets tied to LNG facilities, making Total one of the largest players in the LNG area with Royal Dutch Shell (NYSE:RDS.A). While Total's reserve base is pretty evenly split between liquids and gas (about 50% gas, 40% oil, and 10% oil sands/bitumen), it's more geographically concentrated. Nearly 30% of Total's oil comes from Africa, with Nigeria (11%) and Angola (8%) figuring prominently. The Mideast is another major operating area, generating almost one-quarter of the company's production. Total has only a minimal presence in North America, with about 3% of 2013 production.
As has been the case for most energy majors, Total has seen rising production and development costs crimp profits and margins. Production costs have risen almost 50% over the past five years on a per-barrel basis, with pretax profits falling about 20% per BOE over that time and returns on capital employed dropping from over 20% to around 12%.
Total has over 13 years of reserves at current production levels (around 11B boe), with half of these reserves in Asia (30%) and Africa (23%). Outside of the Canadian oil sands (10%), Total's presence in North and South America (10% combined) is rather small.
Ambitious Growth Targets With Greater Efficiency
If Total hits its 2017 target, production will have grown about 7% a year from 2013 - a remarkable level of growth among the majors today. By way of comparison, BP Plc (NYSE:BP) and Royal Dutch Shell are looking at virtually no growth, as the majors of the world trade off production growth for free cash flow growth and better returns on capital.
Some relatively aggressive assumptions underpin this target. Total is looking for a lower decline rate (3% to 4%) than the norm in the sector (around 5%), and is also looking for major deepwater projects like CLOV, Moho Nord, and Egina and LNG projects like Ichthys and Yamal to come online on schedule and on budget. All told, Total has a number of technically challenging projects that factor significantly into that 2017 production target.
Total has also been among the first among the majors to really emphasize a return to returns-focused spending. Management is looking for 2013 to be the peak capex year at $28 billion, with spending falling to around $24 billion in 2015 and thereafter. Peer-leading growth and capital efficiency would be a potent mix if Total can pull it off, but it's not going to be easy.
While not exactly growth-related, I'd also mention that management has aggressive turnaround plans for its downstream operations. Total operates over 2Mbpd of refining capacity, with more than 80% of it in Europe (making it the largest European refiner). Total's refinery complexity is on the lower end of the scale at 8.2, but management thinks that portfolio realignment, cost savings, and greater synergies can lead to a 13% return on capital employed in 2015. I'd call this a "we'll see" - driving better returns amidst a capacity glut with less complex refineries is hard enough, but potentially closing refineries in countries like France may be more than management can achieve.
Good Costs And Discipline Bode Well
Working in Total's favor, the company boasts peer-best production cash costs (while BP and Royal Dutch are on the other end of the spectrum). Total has also pretty good accumulated know-how and experience in difficult/complex projects - maybe not on the same level as Statoil, but still quite good.
Total's management has also shown that it's serious about getting the most bang for its buck - having recently decided to sell its 10% stake in Shah Deniz for $1.5 billion (Shah is a large gas project in the Caspian, operated by BP) after Statoil also farmed down part of its stake, and halting the Joslyn oil sands project. Together, these two decisions will likely save upwards of $6 billion in capex, though at the cost of some future production growth.
Estimating The Value
Sell-side analysts are generally skeptical that Total can hit its production growth goals, with most analysts forecasting long-term revenue growth of around 2% on basically flat oil prices. I'm a little more optimistic, but I see more value creation in the company returning FCF margins back to the neighborhood of 5%. The market does appear to be valuing Total with a fairly low discount rate (around 7%), which strikes me as aggressive given the commodity, execution, and geographic/political risks.
While discounted cash flow isn't terribly encouraging, Total does look cheap by the more favored metric of EV/EBITDA. This approach has the drawback of focusing only on near-term results, but a 5.5x multiple on 12-month EBITDA (more or less in keeping with the sector) does produce a target of $78 per ADR. Coupled with a yield above 4%, that's not a bad total return.
The Bottom Line
Total has laid out some ambitious plans, and while that raises the risk of disappointment, that risk is tempered by the fact that nobody seems to completely believe those plans will be met. Between the upside potential that management can do what it says it can and the risk that results fall short of expectation (management's and/or the Street's), I still seem value in these shares.
Disclosure: The author is long STO. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.