French integrated oil & gas company Total SA (TOT) reported its Q3 earnings on October 26, 2018. The market was not incredibly impressed; since then, share price decreased by 0.67% despite a couple of spikes.
Nevertheless, since January 1, 2018, TOT has outperformed the major part of its peers and also beaten SPDR® S&P Oil & Gas E&P ETF on the wave of oil price's rally.
Profits and losses
Total SA, as well as all its peers, benefited from the favorable market environment. 9M FY were the months of considerable growth momentum as oil producers reaped the benefits of expensive commodity.
- Revenue from sales surged by 27.9%. We also see a 5% growth Q/Q. By all accounts, recuperated oil prices backed the top line improvement. For broader context, I should say that Eni (E), Italian oil giant and Total’s peer, which I covered recently, reported a 13% increase in net sales from operations in 9M of FY18.
- IFRS net income (group share) increased by 6% Q/Q, 9M IFRS earnings jumped by 36%.
- Interestingly, BP (BP) reported a 156% increase in net profit in 9M of FY18. Nevertheless, we see net income margin of only 3.8%, while Total’s margin is 5.5% and Eni turned 6.56% of total revenues into shareholders’ profit.
- EBITDA margin (ttm), according to computations of Morningstar, is higher than 5-year average, 19.52% against 17.86%.
- Expectedly, higher PBT resulted in a 1.62x increase in income taxes.
- Financial income and expense have not significantly changed.
- All of the above is the result of effective cost management, reasonable capital allocation, and improved production.
It is worth comparing operating margins of the main players of the oil market, in particular: Exxon Mobil (XOM), Royal Dutch Shell (RDS.A, RDS.B), Eni (E), Chevron (CVX), BP (BP), Equinor (EQNR) and, of course, Total. I use the whole group and sub-group to compare the peers better. The upper-end sub-group includes only XOM, BP, RDS.A, CVX, and TOT.
Own creation. Data source: Morningstar
It appears that Total is in the third place in the peer group and in the first place in the sub-group.
Segments' performance: E&P push OCF ahead
E&P segment remains the main EBIT and cash flow driver. Adjusted net operating income in the first 9M of FY18 comprised $11.96 billion. E&P brought $7.73 billion of this amount, around 65%. What is more, 92.5% of CFFO came from exploration and production. In this regard, shareholders should be aware that they invest in the company with fairly versatile business model, but currently, all its operating cash flow comes from production of hydrocarbons.
Source: Third quarter 2018 results, P. 28
What might be considered as Total’s obvious merit is improved production. It is said in the report that the firm produced 8.6% more than in the respective period of FY17 and extracted 2.742 mmboe from its wells every day. In fact, some oil supermajors reported decreased hydrocarbon output due to a variety of issues, turnarounds, for instance. RDS’s production fell by 1.6%, Exxon reported a 2% decrease Y/Y, contrarily, Chevron’s production surged by 9%, BP’s by 8.6%, Equinor’s output rose 1% Y/Y, and Eni reported a 3% increase.
Own creation. Data source: most recent earnings announcements. Note: BP’s 6.8% increase does not include the impact of Rosneft. The output of Rosneft increased 2.8% Y/Y.
It is worth mentioning that Total produces a larger share of hydrocarbons in Europe and Central Asia, 32%. Interestingly, in 9M FY18, combined liquids and gas production in the Middle East and North Africa jumped by 22%, in Europe and Central Asia surged by 16%, but 47% decrease in output in the Asia Pacific partly offset the overall improvement.
Highlights of the quarter
- First, the company closed the acquisition of Engie’s LNG portfolio. Now, the firm is on the 2nd place amongst the key LNG players in the world.
- The Kaombo project in Angola started production. Total SA has a 30% share and operatorship in this ultra-deep-water offshore project, which will produce 230,000 barrels of oil daily in 2019.
- Total launched the second train of Yamal LNG in Russia and Ichthys LNG in Australia.
- The quarter is also remarkable for a few exploration successes, as Total tirelessly enhances its portfolio, in particular: the Glendronach discovery (the UK), Shwe Yee Htun 2 (Myanmar) and Sururu (Brazil).
Cash Flow Statement
Total’s free cash flow generation is resilient, but not spectacular. For the sake of consistency, I shall use the most common simplified definition of FCF, or OCF minus investments in intangible assets and PP&E. I should underline that, in this case, we have levered free cash flow, as far as the company uses consolidated net income as the starting point of OCF. Thus, the figure has been already purified from interest expense. IFRS operating cash flow was $14.06B, and investments in intangibles and PP&E comprised $12.5B. Hence, FCF equaled to $1.53B in 9M FY18 and $4.59B a year ago, consequently, the figure significantly decreased Y/Y.
Source: Third quarter 2018 results, P. 23
Tellingly, Morningstar probably uses the same method, because we have similar YTD FCF figures:
The main culprit of not stellar CFFO is working capital, which surged by 310% and resulted in a cash outflow of $5.7B compared to $1.4B in 9M FY17. As managers clarified in the report, the reason for such an increase is the effect of consolidation of Maersk Oil, Engie LNG, and Direct Energie and the rise of oil prices. In this regard, this fluctuation should be considered as a temporary and not long-lasting flaw.
In an attempt to examine the financial position of Total SA I have calculated several commonly used ratios to analyze the consistency and resilience of the balance sheet. Here are the results:
- Current Ratio comprised 1.4. Current liabilities are safely covered by current assets. It is worth noting that the cash and cash equivalents account for 30% of current assets.
- Cash Asset Ratio was slightly weaker, less than 1, 0.37 compared to 0.44 on June 30, 2018, but on the acceptable level.
- Besides, total debt increased by 9% compared to the end of Q3 FY17.
- Total debt-to-EBITDA is also an accurate indicator of financial health. Total SA reported total debt of $56.2B. Its EBITDA (ttm), according to Morningstar, is $34.98B. In this regard, total debt/EBITDA equals to 1.6x, which is well below 2x, and that deserves high praise. By contrast, with EBITDA (ttm) of $29.22B and total debt of $64.14B BP possesses a total debt/EBITDA ratio of 2.19x.
To compare the oil giants and uncover if Total is overvalued or undervalued, I performed a quick multiples valuation. I used P/E and industry-specific ratios: EV/EBITDA and EV/BOE/D. As I have already mentioned, I divided the peer group into two separate sections: the peer group itself and the upper-end sub-group. Total’s closest peers are the following IOCs:
The upper end of this peer group includes only XOM, CVX, RDS.A, BP, TOT. Here is the comparison:
Own creation. I used RDS.A class of Shell’s shares. Red cells indicate the highest points in the dataset, white – the lowest. Production data were copied from the most recent earnings announcements.
The takeaways are as follows:
- Average EV/EBITDA and EV/BOE/D multiples for the whole peer group indicate undervaluation by 6-9%. P/E ratio specifies 1% downside.
- Contrarily, average EV/EBITDA and EV/BOE/D for the sub-group specify 21-28% discount. P/E ratio indicates 6% upside.
IFRS '16, we are making our first estimate. Our first estimate lead to an increase for our gearing of about 4%. This will be confirmed at our February presentation. There is also a slight effect on the return on equity, which is neglectable, below 1%.
In FY19, IFRS 16 might have a considerable impact on the consolidated statements, EBITDA, gearing, etc.
In sum, the firm reported solid results fortified by new projects start-ups. Total SA, as one of the key players of LNG market, remains a promising long-term energy investment. However, the question in the short term is if the oil bull will run further, or the recent correction will have repercussions.
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.