Back when oil prices started to climb out of the abyss in February 2016, it would have been reasonable to think that oil and gas stocks wouldn't get that cheap ever again. That seemed especially true for the giant integrated oil and gas companies that are some of the best-capitalized businesses in the world, with assets touching every part of the value chain to offset commodity volatility. Yet here we are more than 18 months later, and the valuations for ExxonMobil (NYSE:XOM) and Total SA (NYSE:TOT) are getting incredibly close to the low levels we saw early last year.
Despite the challenges of today's market, there is reason to believe that better days are still ahead for the oil industry. So let's look at why investors seem to be down on these two stocks, and why that pessimism could be offering up another great buying opportunity.
The stable stalwart
ExxonMobil has caught quite a bit of flack lately. Even though the company's earnings are on the upswing thanks to lower production costs and reasonable oil prices, one thing that has been lacking is production growth. Much of the additional production over the past couple of years has barely been enough to keep pace with the decline of legacy assets or offset lost production from asset sales. This has been a significant factor as to why shares of ExxonMobil now trade at a price to tangible book value similar to levels we saw in the 1980s.
If Exxon were to only maintain its current production for many more years, then perhaps today's valuation would be justified. However, there are two major growth catalysts that could help spur production growth in the coming years. The first is its position in the Permian Basin of West Texas. Exxon has been slow-playing its position here for years to figure out the geology and the best extraction techniques, but now it has a position in the region where its development costs are low. Management has been ramping up activity there with additional rigs and will likely continue to do so in the coming years.
The other big catalyst is its offshore field in Guyana. Management has already given the green light for a 120,000 offshore facility that should start up before 2020, and it's already developing a second phase for 300,000 barrels per day. These two development phases represent just a small portion of the total oil Exxon found in this prolific offshore basin. It wouldn't be surprising if we see even more coming from this region soon.
Exxon has always been known for being the steady ship in the stormy sea that is the oil and gas industry. It may not be able to quickly respond, but the elements are there for sustained growth over the next few years.
Ready to pounce on market rebound
Total has been in the exact opposite situation as ExxonMobil in recent years regarding production. Many of the company's largest capital projects have come online since 2015, and it has led to production growth rates well above what investors would normally expect from an integrated oil & gas company. What's also encouraging is that the group has coupled that production growth with significant operational cost reductions for both the upstream and downstream segments of the business.
Thanks to those efforts, Total has been able to achieve two rather incredible feats in the past several quarters. It took the return on equity crown from ExxonMobil, which was the first time in over a decade that a company outperformed Exxon. The other was that Total was able to generate the same level of free cash flow as it did back in 2013, when oil was north of $100 a barrel. Having these levels of profitability have given management enough confidence to invest in new projects and acquire new assets such as its recent purchase of Danish conglomerate Maersk's oil and gas assets in the North Sea.
Even though the company has a high rate of return, a reasonable balance sheet, and the ability to make aggressive acquisitions, shares of Total are still selling for a price to tangible book value of just 1.42 times, the lowest ratio among the integrated majors.
Some investors are a little concerned that management has elected to keep its scrip dividend -- a dividend that is paid out in shares instead of cash -- and that it will be difficult to grow its dividend once it's paying an all-cash dividend again. With Total's dividend yield at 5% already, the concern is certainly justified. However, management plans to keep growing production by 5% or more between now and 2020. If it can continue to keep a lid on per-barrel operational costs while growing production at these rates, then the company should find little issue with getting back to a full cash dividend and a modest growth rating.