Integrated energy giant ExxonMobil was my pick in the energy patch because of its low debt, high yield, and commitment to its dividend. And then a pandemic upended the supply/demand dynamics of the industry and sent oil company shares tumbling. With a roughly 50% paper loss, I chose to sell Exxon to offset capital gains I had in other areas of my portfolio. But I still wanted to stay invested in the energy patch. Here's the full story, and why I switched to a different oil company.
Easing the "pain"
One of the funds I own is heavily invested in Tesla stock. In fact, that's an understatement -- Baron Partners Fund's top holding is Tesla, and it makes up nearly 40% of the portfolio. That's way too much exposure to the electric car maker for my taste, so I chose to sell half of my position in the fund and put that cash into Baron Asset Fund, which has a similar management style and zero exposure to Tesla. The problem with this risk-conscious allocation decision is that it left me with a sizable realized capital gain.
While it's hard to complain about making money, that doesn't mean I want to take the full tax hit if I can avoid it. So I looked at my portfolio for investments to sell that would lead to capital losses. Those losses would allow me to offset at least a portion of the capital gain I had taken, in what's known as tax loss harvesting. Exxon, down materially in 2020, was an obvious choice. The one complication was that I didn't want to eliminate my exposure to the energy patch.
That left me with two choices. If I wanted to stick with Exxon, I would have to simply stay out of the energy sector for at least 30 days to avoid the wash sale rule, which would nullify my capital loss. I chose to stay invested in the energy sector (and actually increased my investment) by purchasing France's Total (NYSE:TOT).
Oil and more
To be honest, Chevron would have been a better direct replacement for Exxon because they both have similar business approaches, relatively low leverage (in the industry), and long histories of annual dividend increases behind them.
However, I wanted to hedge my bet just a little bit. That's the first reason for my decision to pick Total. The European energy giant has laid out a plan to increase its exposure to electricity, notably including renewable power, while Exxon and Chevron are both sticking exclusively to oil. By 2030 Total hopes to generate around 15% of its energy sales from what it calls "electrons." This isn't a new shift, either -- Total has been in the electricity/renewable power area for a while. It's just ramping up that commitment a bit as the world increasingly shifts toward clean energy.
Total isn't the only oil major to announce plans to shift its business in this direction. Royal Dutch Shell and BP have both said they plan to do the same thing. However, those two companies also cut their dividends because of the shift. Total has laid out a plan that it believes will allow it to maintain its dividend and shift its business at the same time. The board, meanwhile, has openly stated that the dividend can be supported as long as the average oil price sticks around the $40 level. Exxon hasn't given nearly as clear guidance, and now at least I have a number to watch. Oil has dipped below $40 recently, which isn't great news. However, it's the average price over time that matters, not the exact price on any given day.
Lastly, Total has a fairly strong balance sheet. This requires a bit of nuance, however, because European energy companies have a history of carrying more debt and more cash than U.S. energy companies. So if you look at debt to equity, Total's balance sheet is heavily leveraged. If you take cash into consideration, however, the net debt picture looks a lot better.
To put some numbers on that, Total's long-term debt at the end of the third quarter was $61.5 billion, with shareholder equity of $104 billion. The long-term debt to equity ratio is roughly 60%. But it also holds around $30.5 billion in cash, so the net debt that Total is carrying is actually around $31 billion. Add that into the equation, and the company's net debt to equity ratio is a much friendlier 30% or so.
I have no illusions here -- I'm still invested in a deeply out-of-favor sector that is facing material headwinds. In fact, as I noted above, I actually increased my position when I added Total to my portfolio. The dividend may or may not hold, but I still believe that oil and natural gas will be important parts of the world's energy mix for decades to come. With a reasonable net debt position, I think Total will muddle through the current headwinds to thrive in the future as its business shift plays out and oil and natural gas recover. In the meantime, I know that $40 oil is the metric to watch on the dividend front. No company is perfect, but Total is the one oil stock that I would (and did) buy despite the industry downturn.