Total - Should You Buy This 5.6% Yielder?

| About: TOTAL S.A. (TOT)

Summary

Total is an oil major with relatively good growth prospects, which has successfully adapted its portfolio and cost base for lower oil prices.

Its recent financial performance reflects the decline of oil prices occurred since mid-2014, with sales, revenues and profits declining considerably over the past couple of years.

It offers an attractive dividend yield of 5.6% that seems sustainable for the time being, but the company needs higher oil prices to offer a "safe" yield.

Total (NYSE:TOT) is a large global player within the oil and gas industry and has naturally been negatively impacted by low oil prices over the past couple of years. Despite this it still offers an attractive dividend yield that seems to be sustainable for the time being, even though it can considered risky if oil prices don't rebound in the coming years.

Total is one of the oil majors which means that it's among the world's largest oil and gas companies. It was founded in 1924 and is based in France. Total has a market capitalization of about $122 billion and trades in the U.S. through its ADR program on the New York Stock Exchange. Its competitors are other large oil and gas companies, such as BP (NYSE:BP), Royal Dutch Shell (NYSE:RDS.A), Exxon Mobil (NYSE:XOM) or Chevron (NYSE:CVX).

Its activities include oil and gas exploration and production, refining, petrochemicals and fuel and lubricant marketing. It has also solar energy operations through SunPower. It has operations in more than 130 countries around the world. Total has an integrated business model, with operations across the entire value chain of the energy industry. Like most of integrated peers, Total's earnings come mainly from upstream operations (exploration and production, usually referred has E&P) even though its downstream operations are also profitable (refining and chemicals and marketing and services).

Total has more than 11 billion of barrels of oil of proven and probable reserves, representing more than 20 years of its annual oil production. Over the past few years it has invested significantly to expand its production capabilities, which is reflected in its average replacement ratio of 118% over the past three years. The vast majority of its production is generated in Africa and the Middle East. Given its large size its production growth is relatively limited over the long term, but in 2015 it was able to report a 9.4% production increase. This strong growth should decelerate to about 4% in 2016 and to around 5% per year in the next few years, a very good growth level for a major oil company.

The energy sector has been largely affected by the decline in oil prices since mid-2014, forcing several smaller players to bankruptcy. Large players, like Total, have more flexibility to adjust their business model to lower oil prices, but their profitability has naturally been curtailed. Total has also adapted its portfolio for the new industry landscape and has a $10 billion asset sale program defined for the period 2015-17. It is delivering asset sales as planned and has increased its 2016 target to $4 billion. This means that Total is focusing on activities where it can earn higher returns and have lower production costs, adapting its portfolio for the current environment of low oil prices.

Regarding its recent financial performance, Total has delivered relatively better results compared to its closest peers, even though it has reported declines on the main key performing indicators in the past couple of years. The drop in oil prices since mid-2014 has affected naturally its sales and results, with revenues declining 7% in 2014 and 32% in 2015 to $143 billion.

Like many of its peers, Total has a cost reduction program ongoing that has already delivered higher operating expenditures (opex) reductions than initially expected. The company's initial target was for $0.8 billion of opex reductions during 2015, but this was revised upwards to $1.2 billion and Total was able to achieve around $1.5 billion in the year.

This good track record on cost cutting bodes well for the future and it expects to reach $2.4 billion by 2016 and more than $3 billion in 2017. This helps to protect margins and smooths to a certain extent the negative impact of lower revenues on net income. Total's EBITDA margin dropped significantly to 11% in 2014, but has recovered a little bit in 2015 showing the benefits of its cost-cutting program. Its net profit has also dropped significantly compared to 2013, to about $5 billion per year in the past couple of years from more than $11 billion before.

During the first six months of 2016, its operating environment has continued to deteriorate with revenues, net income and cash flow generation continuing to decline. Total's sales declined by 20% in this period, compared with the first six months of 2015, reflecting the lower average oil price. In the second quarter revenues have recovered, but this was not enough to compensate the very weak first quarter of the year. Its net income dropped by 34% to about $3.7 billion. Going forward, its financial performance will be naturally dependent on the evolution of oil prices and given the recent rebound on Brent, Total's earnings should improve somewhat in the next few quarters.

Regarding its dividend, Total has a very good history despite the recent drop in its earnings. The company has paid dividends in each year since 1946 and more recently has delivered a slightly growing dividend until last year. In 2015, its dividend remained unchanged from the previous year at €2.44 ($2.68) per share. At its current share price, Total offers a very attractive dividend yield of 5.6%.

Contrary to many European companies, its dividend payment frequency is quarterly making it more attractive to U.S. investors. In the past two quarters its quarterly dividend has remained unchanged, thus its annual 2016 dividend should remain the same €2.44 per share. Indeed, according to analysts' estimates its dividend is expected to remain the same for the next few years, reflecting the challenging outlook that energy companies continue to face. Total has a scrip program ongoing, which means that shareholders have the option to choose dividend payment in cash or new shares. Investors should also take into account that the French dividend withholding tax rate is 30%.

Despite the recent deterioration of Total's financial profile, its dividend sustainability continues to be relatively strong based both on earnings and cash flow. Its dividend payout ratio has remained below 60% over the past three years, an acceptable level for a large company like Total. On cash the recent data is not so supportive given that its free cash flow was negative in $500 million in 2015, due to its large investment program.

Even though Total has a very good cash flow generation from its operations, the company also invests heavily and its capital expenditures (capex) absorb the vast majority of its organic cash generation. In 2015, its capex amounted to $23 billion, while cash flow from operations were about $20 billion. This large investment in new capacity is very significant, taking into account the current challenging environment within the oil and gas industry. This means that Total has some flexibility in its investments and may easily reduce capex to preserve cash and pay dividends. Indeed, Total has reduced its capex over the past few years from more than $26 billion in 2014 to about $19 billion expected in 2016 and between $15-$17 billion in the next few years, has announced at its recent investor day. This will increase its free cash flow generation and provide more resources to pay dividends to shareholders, making its dividend more sustainable over the coming years but with low room for growth.

Another supportive factor for its dividend is Total's strong balance sheet, with a gearing ratio of only 28% at the end of 2015 and a net debt-to-EBITDA ratio of 1.4x. This means that Total does not need to reduce debt in its balance sheet and therefore can allocate almost all of its cash flow generation to capex and dividend payments in the coming years.

Conclusion

The energy sector has naturally been negatively impacted by low oil prices and Total as one of the oil majors has been no exception. Nevertheless, its recent financial performance has been more resilient than peers and is showing good progress on adapting to current conditions, namely through cost-cutting and capex adjustments. Its dividend yield of 5.6% is attractive and seems sustainable, but the company needs higher oil prices to provide a 'safer' income.

Additionally, the investment case for Total seems to be improving given that OPEC has recently signaled that is now in a position to cut oil production and therefore the outlook for oil prices has improved and investors are turning more bullish. This is positive for oil & gas companies and a possible rise in crude prices is also positive for stock prices, given the beta and earnings elasticity to higher oil prices. Therefore, Total seems to be a good way to play recovering oil prices with the additional positive factor of a high-dividend yield.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

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