The entire energy sector is going through a fierce sell-off due to the pandemic, in contrast to the rest of the market, which is hovering around its all-time highs. In such sell-offs, the solid companies are usually punished along with the weak ones. This is the case for Total (TOT), which has plunged 38% this year. Total is much more resilient than the other oil majors in the ongoing downturn and thus it will highly reward investors when the pandemic subsides.
Royal Dutch Shell (NYSE:RDS.A) (RDS.B) and BP (BP) have plunged much more than Total, to their 25-year lows, while Exxon Mobil (XOM) has plunged to its 17-year lows. Consequently, these oil majors may offer greater returns if the energy market recovers strongly from the pandemic. However, there are good reasons behind their significant underperformance compared to Total. The latter is much more resilient at the suppressed oil prices prevailing right now and hence it can endure the downturn much more readily than its peers. It is not accidental that Total is the only profitable oil major this year. As a result, if the downturn lasts longer than expected, Total will perform much better than its peers.
The coronavirus crisis has caused an unprecedented downturn in the energy sector. The global demand for oil products is expected to slump by 8.1 million barrels per day on average this year (~8%) before it rebounds by 7.0 million barrels per day next year. This contraction, which is the steepest in at least three decades, has resulted in suppressed oil prices and low refinery utilization rates. Consequently, Exxon Mobil, Chevron (CVX), BP and Royal Dutch Shell are all expected to post material losses this year.
The only bright exception is Total, which is expected to achieve earnings per share of $1.20 this year. In the first half of the year, its Gas, Renewables & Power segment grew its operating income 21% and thus it provided a strong buffer to the total results of the company. Even in the second quarter, which was marked by unprecedented lockdowns, Total was the only oil major that managed to post a (marginal) profit, whereas all its peers incurred material losses.
A similar picture was witnessed in 2019, which was marked by lower oil and gas prices than 2018. Due to the unfavorable oil and gas prices, Exxon Mobil, Chevron, Shell and BP saw their adjusted earnings per share decrease 50%, 20%, 30% and 21%, respectively. Total outperformed its peers, as its earnings per share fell only 13% thanks to the solid earnings of its refining segment, its marketing segment and its LNG business.
Thanks to its resilient asset portfolio and the low-cost barrels it includes, Total has repeatedly confirmed that its dividend is safe at oil prices around $40. In fact, its cash break-even oil price (without including the dividend) is $25. Overall, Total is by far the most resilient oil major and has proved its superior resilience in the last three downturns, i.e., in 2014-2016, in 2019 and this year.
Total was in strong growth mode until the onset of the coronavirus crisis. The oil major grew its production 8% in 2018 and 9% in 2019. These growth rates were the highest in its peer group and Total was expecting to grow its output by another 2%-4% this year, until the pandemic struck. Due to the plunge in the global demand for oil products and the resultant production cuts of OPEC, Total has maintained essentially flat output this year.
However, its long-term prospects remain promising. It is irrational to expect the pandemic to condemn humanity to a permanent recession. Numerous vaccine studies are underway right now, with the most promising prospects coming from Moderna (MRNA), Johnson & Johnson (JNJ), AstraZeneca (AZN), and Pfizer (PFE). These pharmaceutical giants have already identified effective vaccines against the coronavirus, but they still have to prove that their vaccines do not cause side effects on a large scale (30,000-60,000 people). A vaccine is widely expected to be approved by the FDA early next year and distributed worldwide in about a year. As soon as a vaccine is widely distributed, the pandemic will subside, and the demand for oil products will recover.
Total has a strong pipeline of growth projects, which have a rate of return above 15% and will enhance its production by more than 800,000 barrels per day after 2023. It is also worth noting that Total benefits from the low natural decline of most of its fields, which exhibit long plateau profiles. This is a significant advantage, as the natural decline of oil and gas fields is a strong headwind for all the oil majors.
Moreover, Total has a great record in the replenishment of its reserves. In the last five years, the oil major has posted an average reserve replacement ratio of 124% and thus it has achieved a 12-year lifetime of proved reserves. This is higher than the average 11-year duration of reserves in the group of oil majors. On the contrary, Shell has posted an average reserve replacement ratio of only 48% in the last three years and thus the lifetime of its reserves has decreased to just 7.9 years. To cut a long story short, Total has great growth prospects ahead thanks to the quality and durations of its reserves as well as its promising growth projects.
Total is currently offering a 9.0% dividend yield. Due to the uncertainty over the duration and the severity of the pandemic, the dividend of Total should not be considered entirely safe. On the bright side, Total has repeatedly stated that its dividend is well covered at oil prices around $40.
It is also worth noting that Shell and BP have already cut their dividends by 66% and 50%, respectively, this year. Exxon Mobil and Chevron are the only two dividend aristocrats in the energy sector and thus they will exhaust their means to defend their dividends. However, Exxon Mobil is expected to incur a huge deficit in its cash flows this year and hence its stock options that expire next year have discounted an approximate 40% dividend cut in the upcoming months.
As mentioned above, Total is by far the most resilient oil major in the ongoing downturn. Since the previous downturn of the energy sector, which was caused by the collapse of the price of oil from $100 in mid-2014 to $26 in early 2016, Total has drastically high-graded its asset portfolio, with the addition of low-cost barrels. It has also reduced its operating expenses from $9.9 to $5.4 per barrel of oil produced. As a result, its cash break-even point has fallen below $25 per barrel.
Source: Investor Presentation
Overall, the dividend of Total seems safe even under the adverse conditions prevailing right now. On the other hand, if there is another round of extensive lockdowns worldwide, the price of oil is likely to plunge once again and thus it is likely to put the dividend of Total at risk.
As mentioned above, the pandemic is likely to subside next year thanks to the expected development of a vaccine. As a result, the energy market is likely to begin to recover next year. Analysts thus expect Total to earn $2.85 per share in 2021 and $3.79 in 2022. These estimates look reasonable, as they are lower than the earnings per share of $4.38 posted last year. It is also reasonable to expect Total to grow its earnings per share significantly off this year’s figure of $1.20, which is a 10-year low, as the earnings of this year have been severely hurt by the unprecedented lockdowns.
Moreover, Total has traded at an average price-to-earnings ratio of 12.4 over the last decade. As soon as the energy market begins to recover, the stock can be reasonably expected to revert to its average valuation level. Therefore, if the company meets the analysts’ expectations, it is likely to trade at approximately at $47 (=12.4 * 3.79) by 2022. As a result, the stock has 42% upside from its current price, without including its dividend. This is an exceptional risk-adjusted return, particularly given the resilience of the company in the adverse scenario.
The entire energy sector has been beaten to the extreme due to the pandemic. As a result, Total has become grossly undervalued and hence those who purchase it now are likely to be highly rewarded in the long run, when the dust settles and the panic subsides. The other oil majors have plunged much more than Total and thus they may offer greater returns, particularly if the energy market enjoys a swift recovery. However, conservative investors should probably select Total for its resilience in the event of a prolonged downturn. In this way, they will be able to remain patient much more readily throughout the ongoing downturn.
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.