True value investors pick unloved dogs trading well below intrinsic value that will in time become stars and reach their full potential. We believe Total (NYSE:TOT) is a nice case study which offers a look into the mind of such investors.
Although over the last few years TOT has underperformed most of the other majors, its high risk-high return strategy of inorganic growth projects is coming to a head with promising increases in cash flows and decreasing levels of capex on the horizon. Although surpassing its 52-week high on practically a daily basis, TOT represents an investment which will increase in value and provide an impressive dividend stream over the long term. From 2010-13, TOT's net operating cash flow averaged about $21 billion, which meant that their $7 billion dividend (EUR 2.36 per share) had to be funded from divestments ($31 billion of assets have been sold since the beginning of 2010).
Although asset sales are not intrinsically problematic as the energy majors often reshuffle their portfolios, using divestitures to address shortfalls in cash flow are. Further, the company has seen a decrease in real earnings over the last 5 years and has seen a decline in production of 2% from 2008 to 2013. Over this period the market took a dim view of the company and with the exception of BP, Total's stock has underperformed all of the majors since 2008.
Yet, over this period CEO Christophe de Margerie who became CEO in 2007 has lead his company to develop a strong pipeline of upstream growth projects as well as an aggressive restructuring of its downstream operations. These initiatives have been geared towards TOT's promise of cash flow growth.
The market has been preoccupied with this promise as capex has averaged $31 billion the last four years, which is quite high for companies like TOT. These high levels of spending have been the major reason dividends are largely unchanged since 2008 (the company raised its dividend once, with a 3% increase in 2012).
Simply put, TOT is increasing production and reducing capex which in theory is a simple formula to enhance operating margin, yet in practice is very difficult to accomplish. TOT is expected to increase production 4% year over year and as set a 3.0mboe/d production output by 2017 which is a 30% increase. Their list of new fields is also quite impressive and will definitely offset the reduced production from 2008-2013. Moreover, similar to XOM and CVX, 80% of its earnings are to come from its upstream segment, which is a much more profitable segment over the longer term.
One of the great things about this company is its transparency with respect to its operations. TOT is the only one of the 3 companies that provides sensitivity figures for the dependence of its net income on the price of Brent. More specifically, its net income increases by about $112 M for every $1 increase in Brent.
The price of Brent has consolidated in the range $90-$110 and is expected to continue trading around this range in the next few years. As described above, the EPS of TOT are expected to rise from 6.3 in 2013 to about 8.2 in 2017. Based on these numbers, one can calculate the EPS (in $/share) of Total in 2017 for a range of prices of Brent ($99-$119). The average price in 2013 was $109/bbl.
Oil price = $99, $104, $109, $114, $119
EPS = $7.9, $8.1, $8.2, $8.4, $8.6
The results show that the EPS of TOT in 2017 will be in the range 7.9-8.6 if the company meets its production outlook and the price of Brent does not change dramatically. With a $109 level EPS of 8.2 and assuming conservatively the stock remains at a depressed valuation near 10, TOT will yield capital gains of about 30% until 2017 on top of the near 5% dividend yield it already provides.
Again, this will all depend on management execution and margin controls, which for any business, is the source of sustainable growth going forward. Yet, if these factors hold up, TOT will represent the quintessential case study of a dog turning into a star over time. Buy and hold for dear life….
-Peter Mantas, Chief Investment Officer
-Matthew Castel, Head of Strategy and Investor Relations
Disclosure: I am long CVX.