It's not easy for a company like Total (NYSE:TOT) to stand out in the integrated oil and gas space when it is dominated by names like ExxonMobil (NYSE:XOM) and Chevron (NYSE:CVX). Just because it isn't the household name doesn't mean that investors should write it off, though. Like ExxonMobil and Chevron, Total has the benefits of size and scale in the oil and gas industry, an industry that will likely remain in high demand for many years to come.
The better question for companies like this isn't if you should buy shares, but when. Buying at the wrong time (when oil prices are extraordinarily high) can mean that you overpaid, and it will take considerably longer for you to make a return on your investment. To help you get a better grasp of whether buying shares of Total is the right thing to do or not today, let's take a quick look at how it stacks up against its peers as well as how the company looks from a valuation standpoint.
Total's case that it should receive your investment dollars
When looking to make a choice between integrated oil and gas companies, Total doesn't really stand out that much. The new production projects that it has planned between now and 2013 have some of the highest estimated rates of return in the business. According to management, these new projects should generate $50 per barrel of oil equivalent in operational free cash flow.
The problem, though, is that you cannot simply buy just the future upstream projects of the company. When we look at Total as a whole, its average return on invested capital over the past five years falls well behind both Chevron and ExxonMobil.
One of the big reasons that the company's earnings have not kept pace with the leaders in the space is because it has been spending so much money on new projects. Total's management anticipates that this issue will be alleviated. 2013 was supposed to be the year where capital spending peaked as several new projects were ramping up, and the company is looking to divest itself of up to $20 billion in underperforming assets to improve returns.
This story may sound very similar to a couple other players in the space -- Shell (NYSE:RDS-B) and BP (NYSE:BP) also have large asset divestment plans in place. The major difference between them, though, is that Total also has plans to substantially grow its production over the next couple years with those high cash margin projects.
If Total can execute this strategy -- which will involve bringing these new production projects online both on schedule and within budget -- then it should significantly increase its operational cash flow while reducing capital expenditures. These two things could go a long way in improving Total's overall returns and could mean that share prices could rise significantly over that time.
Scouring through the numbers
Investors who are new to the energy space can get fooled into thinking that they are buying a company for a great value because it is cheap when compared to the S&P 500 average. Here's the problem with that theory: The energy sector habitually trades at a discount to the broader market because oil, gas, or any other type of energy is a commodity and is therefore likely to suffer cyclical booms and busts. Just to give you an idea of this deep discount, the Robert Shiller adjusted price-to-earnings ratio for the entire energy sector sits at only 15.9x while the broader S&P 500 has a Shiller adjusted P/E of 26.3x.
With that in mind, let's take a look at the numbers for Total and its peers in the Big Oil space.
|Company||Price/Earnings||Enterprise Value/EBITDA||Enterprise Value/Total Revenue||Price/Tangible book value|
|Royal Dutch Shell||16.0x||5.3x||0.7x||1.5x|
This table pretty much says it all -- all of these companies trade at extremely similar levels that don't really garner a whole lot of investor excitement. Also, Total is pretty much the middle of the road in every category. The same thing can be said when you compare Total's valuation to its own historical valuation. The historical valuation is the average value for each quarter over the past 10 years.
|Total's Valuation||Today||Historical Average (last 10 years)|
|Enterprise Value/Total Revenue||0.8x||0.83x|
These numbers can seem a bit confusing. How can a company be overvalued compared to its historical average on a price to earnings basis, but be undervalued on a price to revenue basis? One explanation could be that over this time frame, margins at Total have declined slightly. With the exception of two quarters at the bottom of the financial collapse when oil prices were as low as $40 a barrel, gross margins never slipped below 30% between 2003 and 2011. Since, then, though, Total has seen several instances of lower than 30% margins, and today it stands at 28%. These lower margins normally mean that the company's revenue is slightly less valuable than its peers.
Overall, though, these numbers aren't so far off from their historical averages that they should inspire any excitement from investors hoping to buy shares on the cheap.
What a Fool Believes
Where Total is currently positioned in terms of operations and valuation compared to its peers, it looks pretty bland. Then again, being bland with a dividend yield of 4.7% isn't that bad, either. A high dividend like that can go a long way in generating long-term returns for someone who wants to reinvest those dividends over time. The one thing that is exciting about Total is its future, the current strategy to divest weaker assets, lower the spending rate, and bring on a huge slew of projects in the next couple years will make Total a very interesting company to watch over the next couple of years.
Overall, there just isn't quite enough there for me to want to buy shares of Total today, but I certainly will be keeping an eye out for a more opportune time when other people overreact to low oil prices or any of the other numerous risks associated with a commodity-driven business like oil and gas.
The Motley Fool recommends Chevron and Total (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.