Saturday, December 19, 2015

5th AIM student equity update (by Patrick Sanchez): Total S.A. (Ticker TOT): Is it TOTALly over?


TOT (Total S.A.): "Cheap Oil: Is it Totally over for TOT?"
By: Patrick Sanchez Mitchell, Student at Marquette University

Image result for total s.a. logo

Disclosure: The AIM International Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

 Summary
• Total is a mega global oil and gas company headquartered in Paris, France. Total’s revenues are under heavy pressure due to the current, massive slump in oil prices ($35 spot price for WTI crude). How low will oil go and for how long - and can TOT weather the storm?

• The company’s margins have declined and management recently declared that it has entered a new business cycle. TOT has adapted quickly to cut down on costs in order to reach a lower breakeven price (US$40 per barrel).

• Currently, management is focused on acquisitions, return to shareholders in the form of dividends, and reducing its capital expenditure schedule. Steady cash flow from operations is expected to make this possible.

• Management has indicated that it will continue to cut down overall costs in order to mitigate the current weak commodity environment. TOT's managers realized that stronger volumes couldn’t fully offset substantially weaker oil pricing.
• If oil prices continue to decline, Total could be heading to new 52-week lows --- as production operations wouldn’t remain profitable.

Total S.A. (NYSE:TOT) remains solid integrated oil company compared to its peers. TOT is returning above industry average returns despite enduring headwinds from a weakening commodity environment. The company is under pressure to remain profitable and to satisfy its shareholders. Therefore, Total’s management remains committed to cost reduction programs; however, weakness in the company’s revenues caused by low oil prices have hurt earnings per share. Further, Total currently has a debt-to-equity ratio that is higher than the industry's average (0.58 vs. 0.49)—and this needs to be evaluated further as the economy moves to a higher interest rate and credit spread period.

Management has declared that since the fall in oil prices of over 50% since last year, Total has demonstrated its resilience by lowering its operating costs. The company is benefited by its integrated model and production discipline in order to limit losses on net income—and Total’s net income has decreased only 16%, while the price of oil has fallen over 50%. The loss was due mainly to its dependence on its Exploration and Production segment; however, its Upstream margins are ahead of schedule as a result of the successful execution of its cost reduction program ($1.2 billion in savings realized for 2015).

During the third quarter of 2015, Total posted impairments of $650 million and inventory valuation changes of $760 million—this dropped net profit to $1.08 billion (-69% YoY). Despite the negative results, the company did exceed earnings per share expectations by $0.26. This surprise indicated to investors that TOT is one of the industry's best managed major integrated oil companies. Also, the firm saw a strong increase of 90% in utilization rate for their refining and chemicals segments. Total’s solid capital allocation and reduced cost spending programs should allow it to continue to outperform its peers in the future.

TOT has taken advantage of the industry's collapse by acquiring two major projects: Surmot 2 in Canada and Gladstone in Australia. This demonstrates that Total has no trouble in allocating capital towards future growth. Furthermore, Total's recent partnership with Chevron to develop project Moho Phase 1b has now started production and is expected to increase output substantially. TOT has a total participation interest of 53.3% in this project.

What has the stock done lately?
Due to the continued decline in oil prices, Total has introduced restructuring plans to cut down on costs and improve results. However, since October 2015, the stock has declined by 12% following oil prices (which recently reached a seven-year low). Consensus forecasts indicate that this decline will continue as OPEC recently declared that it would continue to keep pumping oil and add to the world’s total supply.

Past Year Performance: TOT has decreased 9.7% over the past year, further indicting that the stock is a bargain if you assume that oil prices will rebound from their seven year lows. Total has underperformed the S&P 500, in part reflecting the decline in revenues compared to last quarter’s revenue. Looking ahead, the company’s growth numbers do not indicate a reversal in the decline experienced over the last twelve months. Despite the strong decline, the stock is selling a for higher relative value than its peers.

Source: FactSet

My Takeaway

Despite the headwinds surrounding the industry, Total has shown signs that indicate it is stronger than its industry peers.  In general, some factors indicate TOT's strength and some show weakness. Among the strengths of the company are a strong management team and an integrated model of production. On the other hand, weaknesses include higher leverage, decreasing return on equity, and lower profit margins as a result of falling oil prices. There is little evidence to predict Total’s performance moving forward in a struggling commodity environment. Further, shareholders have shown frustration in its performance, which has put pressure on management. Total’s success will continue to depend on oil prices and the efficiency of the managers and directors. If oil prices rebound, Total is one of the most attractive major global oil companies and should outperform its peers

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