With a promising global energy outlook, improving macroeconomic conditions, and oil companies entering a new phase of portfolio development, the oil and gas sector is expected to perform better in 2014. Eni SpA (E +2.48%) and Total (TOT +0.00%), two European oil majors, not only offer investors value but also growth in production and cash flows in the next few years. However, Eni faces near-term risks, and there is a larger uncertainty surrounding the Italian company's downstream and upstream businesses compared to Total.
Eni's near-term challenges
Due to the challenges faced in Libya and Nigeria and a weak downstream asset portfolio, both companies reported weak 2013 earnings. Going forward, in terms of profitability, both these companies offer a similar asset portfolio; however, the near-term challenges and uncertainties faced by Eni are much greater than those faced by Total. Total's portfolio appears to offer lower risk due to the geographical diversification. It has only 15% of its production activity exposed to the high risk regions such as Africa, whereas, in comparison, the geopolitical hotspots such as Nigeria, Egypt, and Libya account for nearly 40% of Eni's production.
Eni's better long-term growth
While Eni has a superior exploration program and a higher-margin long-term portfolio, the near-term challenges faced by the company are expected to outweigh these factors. However in the long term (post-2017), Eni has a better and more profitable set of upstream projects than Total. This is primarily driven by Eni's greater investment in exploration in the last decade, which has allowed the company to add resources equivalent to more than double production in the past few years. Total, on the other hand, has struggled to replace its production organically. The long-term growth of Eni should be supported by the upstream division of the company, which has yielded a cumulative improvement in the resource base of 7.2 bboe from the discoveries, including Mozambique.
Recent past not much different, but the future should be
In terms of past performance, neither company has a good track record of delivering its volumes target. Since 2005, Eni's volumes have fallen 7% while Total's volumes fell 8%; moreover, neither of the two met its production target. The lag can be explained primarily by the geopolitical outages, divestments, delays in the projects, and the impact of both PSC contracts and OPEC quota cuts. If we consider past performance as a benchmark, it will be difficult to differentiate between the two companies, except 2007-2009 when Eni outperformed Total. However, the next few years will be very different for both companies. While both Total and Eni are expected to deliver production and cash flow growth and share a number of projects, Total is expected to deliver slightly better operational and financial momentum than Eni.
One of the starkest differences between the two companies is PV10 per barrel, a common measure used in the oil industry. Based on this metric, Eni has been consistently placed higher than Total, with the gap widening between the two companies in the recent years. It is mainly attributable to the kind of production Eni is bringing on stream by 2017, which would be predominantly onshore with less LNG and deepwater developments, and cash flow margins are likely to involve lower unit capex.
Total ahead in cost savings
Within the downstream businesses, both Eni and Total have launched ambitious cost savings programs. However, Total is far ahead of the game. The French company aggressively started these programs three years back and its efforts are now bearing fruit. Particularly in the last 12 months, Total has consistently outperformed market expectations. Total is targeting $650 million of synergies and has already realized $250 million. Eni on the other hand started its cost saving program late and has more work to do than Total. But the company has shown improvement, particularly at Versalis, which is expected to drive improvement in profitability or at least cut down losses.
However, as mentioned earlier, despite the improvement shown by Eni lately and more cost savings to come in the future, Total has made greater progress. Moreover, the stability of the marketing and supply business of Total is preferred over the downstream gas and power business of Eni.
Valuation
Total is currently trading at a discount compared to Eni and the industry as a whole. Total has a forward price/earnings ratio of 9.0, significantly lower than Eni's forward price/earnings of 18.9. Moreover, Total has current price/earnings of 12.9, compared to 17.2 for Eni. Total has a price/sales ratio of 0.6, in line with industry average 0.6. Finally, the French company has a price/cash flow ratio of 5.1, compared to 6.7 for the Italian company. Both these companies offer a high dividend yield as well: 4.6% for Eni, and 5.1% for Total.
Bottom line
As mentioned earlier, both these European oil majors offer value to investors and growth in production/cash flows. However, Eni faces greater near-term challenges in both upstream and downstream. Total on the other hand is delivering greater production growth in the next three years. The French company will also be delivering greater cash flow growth in its upstream business. This is largely due to a great proportion of Eni's production associated with high-risk regions including Egypt, Libya, and Nigeria.
Both companies continue to struggle in downstream businesses; however, Total's restructuring efforts have shown more improvement lately than Eni. Total is also trading at a discount to Eni and offers higher dividend yield. While post-2017 Eni's investment thesis should improve considerably, in the near term I prefer Total.
