Total Looks Extremely Cheap

Total Looks Extremely Cheap

Since the North Sea Elgin Platform gas leak three weeks ago, Total S.A. (TOT) has lost an astonishing $15B in market cap. From the March peak of over $56 per share, Total is down over 15%, closing yesterday at $47.72. Adding insult to injury, the likely expropriation of YPF's oil and gas assets in Argentina is causing fear over Total's production in that country. However, as I'll point out below, I estimate the worst case impact of the Elgin platform gas leak to be $1BB, and the any impact from Argentina is likely quite small from a profitability perspective.

Basics:

• Company: Total S.A.
• Ticker: TOT
• Price: $47.72
• Shares: 2.4BB
• Market Cap: $112.8BB
• Debt, net: $21BB
• TEV: $133.8BB
• EBITDA 2011: $32BB
• TEV/EBITDA: 3.2x
• 2011 EPS: $7.05
• 2012 EPS: $7.65
• Forward P/E: 6.2x
• 2011 FCF/Share: $5.00 (using maintenance capex at 3yr avg F&D costs)
• 2011 Dividend: $3.10 (44% payout ratio)
• 2012 Dividend Est: $3.00 (down due to exchange rate assumptions)
• Yield on 2012 Div's: 6.3%

Company

Total is the 5th largest publicly traded oil and gas company in the world, one of the "big six," so to speak, which include Exxon (XOM), Shell (RDS), British Petroleum (BP), Chevron (CVX), and Conoco (COP). Total now trades far cheaper than all the others, with the exception of British Petroleum, which it trades at a similar 6.2x 2012 EPS multiple.

85% of Total's EBITDA comes from its upstream businesses (that is oil and gas production), with the balance in chemicals and refining. Production is just about evenly split between natural gas and oil on an energy equivalent basis. Chemicals and refining are tough, low-return businesses, requiring huge amounts of capex and maintenance, and subject to tremendous earnings volatility.

It's not surprising that Conoco is shedding via a spin its refiners, and Total has been selling downstream assets as well as buying upstream assets as it shifts its mix even more toward oil and gas production. Good news too: Total has sold its downstream assets for a $4BB gain in the past 2 years.

Total's balance sheet also looks healthy. With $44BB in debt, and $23BB in cash, the company should have no problems funding its growth capex needs, as well as any costs from Elgin's problems. Leverage clocks in at an uber-conservative 0.66x Debt/EBITDA (or 23% net debt to equity).

Finally, Total has been a reasonably efficient explorer of assets. Finding & Development costs for its oil and gas have been quite low. On a three year average basis, Total has spent $12.42 per barrel equivalent in developing reserves. The trend hasn't been bad either. In 2011, F&D costs were $10.35 per barrel, lower than 2010 and 2009.

While oil and gas production has remained mostly flat over the last five years, management aims to increase production by 2.5% per year through 2015. In 2011 Total replaced 185% of its oil and gas production, and management has touted 25 project startups that should add 600,000 barrels per day to its existing 2.3mm production. These slides offer a good summary of the company.

Elgin

The gas leak at the Elgin Platform spooked investors, as fears of a repeat of BP's Macondo disaster in the Gulf of Mexico reverberated on Wall Street. However, the Elgin situation is far different. First of all and most importantly, nobody was hurt. Elgin was quickly evacuated and powered down. Gas leaking and bubbling at the surface posed a very real risk of explosion; however, given that flares in the vicinity were quickly extinguished, this risk has been mitigated substantially.

While gas is actually leaking, natural gas is far different than an oil spill, where physical cleanup costs are extremely expensive and environmentally damaging. In this case, the gas simply bubbles to the surface and evaporates. No clean up costs, and arguably no environmental impact at all. In fact the Scottish government has said testing of water and sediment nearby the well indicated no marine contamination. Total has shut in production at the well, and in fact the only costs to be incurred will be the lost production and the rig costs for the 2 relief wells, which began drilling earlier in the week.

Total estimates that they will spend around $2.5mm USD per day, including lost income and drilling costs. If it takes 6 months to complete the relief wells as expected, then $450mm looks like as good an estimate as any. In reality it probably will be higher, but even if it's a $1BB hit, then somehow there is still quite a disconnect to the $15BB in lost market cap that the stock has suffered. I haven't factored in any business insurance that likely will mitigate these expenditures.

Argentina

Last Monday, the Argentine government announced plans to nationalize its biggest oil company, YPF (YPF). Rumored for a couple of months, it appears likely that the government will expropriate Repsol's 51% stake in YPF, which is a huge percentage of Repsol's (REPYY.PK) asset base and reserves. The chorus of international criticism has been steadily growing since the news came out. The head of the World Bank, the Spanish government, the Mexican government, and much of the G20 likely will retaliate in some fashion for this move.

In any case, Total owns some producing assets in Argentina, and yesterday fears of the company losing these assets sent the stock down another 2.6%. Three things of note, however. One, Total's production in Argentina is around 86,000 barrels per day, only about 3.6% of their total production.

Two, given that natural gas and oil prices are regulated at far sub-market prices, the profitability of their production is probably quite low. Losing 3.6% of their production would likely impact the bottom line by a much smaller percentage.

Three, most of the government's criticism of YPF is the fact that Repsol has allowed YPF's fields to deplete, in effect milking the business for cash and letting production fall 18% over a 12 year period. During this time the country needed more and more fuel of course. On the other hand, Total's Argentinean production has actually increased each year for the past 3 years, from 80,000 barrels per day equivalent in 2009, to 86,000 last year.

Even better news is the fact that Total has meet with the Argentinean Planning Ministry and vowed to increase production another 5%. Expropriation of Total's assets here seems highly unlikely, and the government has also made it known that other E&P companies are safe. They will need outside investor expertise to find, drill and complete wells in Argentina, so alienating every existing operator in the country isn't likely.

Valuation

The six biggest integrated majors (excluding Total) trade at an average multiple of 7.5x 2012 estimated earnings. Arguably XOM should trade at better multiples given its higher Returns on Equity (ROEs), but I think Total's multiple contraction in the face of very minor hiccups seems overdone.

At the very least, given that Total expects to grow production by 2.5% per year through 2015 (even after Elgin), it should trade as well as Conoco, which generates similar ROE's and is struggling to grow production at all. COP trades at 7.8x earnings.

British Petroleum has seen production decline 10% from its peak, and expects flat production in 2012. With all the uncertainty associated with its Gulf spill liabilities, seemingly it should trade at the lowest multiple in the industry.

Perhaps more important is to use history to see where Total has traded in the past. Excluding 2012, Total traded between 7.2x earnings and 21x earnings going back to 2002. At the depth of the financial crisis in early 2009, Total languished at around $40 a share, implying a 7.8x multiple on the stock using 2009 EPS numbers.

To me it seems that the worst case for the equity here is a 6x earnings multiple, perhaps the lowest any big cap E&P company has ever traded. Further, using reduced earnings of $6.50 a share, down 10% from 2011's results would make a downside case that is doubly conservative. Assuming investors still receive $3 in dividends over the next 12 months, indicates a downside case of $42 per share, or down 12%. ($6.50 X 6 + $3 in dividends = $42).

On the upside, fast forwarding 6-12 months, I believe Total can complete its relief well in the North Sea, and essentially put the problem behind them. Whereas BP still remains in the penalty box given the long tailed nature of the remaining cleanup costs, Total should expunge its liabilities once the leak stops. The UK government doesn't seem likely to impose fines or punitive damages to Total, nor are there lawsuit-happy entities with any meritable arguments who might sue the company.

That being the case, my base case is that in 12 months, Total can trade at 7.8x its 2013 estimates of $8.00 in EPS (4.5% growth), to $62 per share. With $3 roughly in dividends on top, that is a one year total return target of 37%.

Final Note On Dividends

Total targets a 50% payout ratio on average. Dividends have remained steady at €2.28 per share since 2008, despite the fact that EPS has improved from $5.10 in 2009 to over $7.00 today. It wouldn't surprise me for Total to finish cleaning up Elgin, then announce an increased dividend to, say, $3.50 a share, which would be around €2.65 per share. The 15% tax that the French government withholds to US investors is fully credited against taxes here (ie simply timing differences on dividend taxes, not tax rate differences).

Disclosure: I am long TOT.