Last quarter, Total SA's (TTE 2.80%) earnings looked like a gem compared to its Big Oil peers. Strong downstream results coupled with just enough resiliency from its exploration and production business suggests that Total may be the best stock in its space right now.
The company may be doing rather well despite the current oil and gas market, but it isn't simply sitting on its laurels based on these results. On its most recent conference call, Total CEO Patrick de la Chevardiere gave investors some very insightful information about the company's future. Here are five quotes from de la Chevardiere that any Total investor should ponder.
The refining party may start winding down
Over the past two quarters, Total has benefited immensely from very favorable refining margins, especially in Europe. The European Refining Margin Indicator last quarter was at the highest it has been in a decade, and the second quarter was quite strong as well. According to de la Chevardiere, though, investors may want to temper their expectations for the upcoming quarter:
The European refining margin indicator in dollars per ton has decreased to the low 30s for October. We have no way to know if this trend will continue or reverse, but we know that this time of the year can be seasonally weaker because we are between the summer driving season and the winter heating oil season. In any case, it shows the importance of our strategy in the Downstream to reduce the breakeven to less than $20 per ton at each site, and our successful cost reduction program is an important part of this. Our resilience in a volatile environment is largely the result of maintaining strong integrated business units that can prosper in a variety of scenarios. And clearly, we recognize the importance of the Downstream contribution to the resilience of the group.
Without those high downstream margins, already low earnings results could get even worse. This may not be as bad for Total than some of its Big Oil peers because its upstream profits have been much more resilient, but the last thing investors want is more bad news.
Being creative with the dividend for now, but shouldn't need to for long
Paying out a dividend for any energy company right now is tough. Low prices have reduced operational cash flows to a trickle with very little, if any, left over after capital expenditures. To reduce the cash costs of its dividend, management has issued a scrip dividend, where investors get additional shares in the company in lieu of cash. It's not an ideal way to pay dividends, but it can be effective over a year or so to maintain payments. According to de la Chevardiere, the program has been very popular among its shareholders, but it believes that within a year it won't need to keep it up:
The take-up on the scrip dividend was 60% in October compared to 54% in July. According to our long range plan with Brent stable at $60 per barrel, we can cover our CapEx and dividend organically by 2017. So we will be able to stop the scrip. But until then, it is reducing our cash outlay by about $3 billion per year. Going forward, we have the strongest production growth among our peers. We are reducing costs, and we are reducing CapEx.
Even though $60 per barrel sounds like a high price today, over the long term, it looks to be a pretty decent price level to use for budgeting purposes. If the company can fully fund its capital spending and all of its dividend with cash by 2017 with $60-per-barrel oil, then Total could be in pretty good shape over the long term.
LNG is a big deal for us
For most investors in this space, the first integrated oil and gas company that comes to mind when talking about LNG is Royal Dutch Shell (RDS.A) (RDS.B). Once the BG Group merger is complete, the company will have more than double the LNG production capacity of any other Big Oil player. Even though Total's LNG footprint is smaller than Shell's, that doesn't mean it's an insignificant part of the business. As de la Chevardiere pointed out, LNG is a huge part of the business:
[T]his is true that LNG producing only 15% of the produced -- providing only 15% of the production, and 30% of the result was a very positive result. And obviously, LNG is a core business for us. It's a long-term business. And based on our projection for global LNG demand, which we expect growing but at about 4% per year, we expect the market to tighten around, again, by end of the decade.
That's right: LNG is currently responsible for about 30% of Total's upstream profits even though it's only 15% of production. In the coming years, LNG could become an even larger component than that. Its Yemen LNG facility has been down for some time because of the civil conflict; it just started loading cargoes at the Gladstone LNG facility; the Yamal LNG facility in Russia is 30% complete; and the company is in the planning stages of another LNG facility in Papua New Guinea. Hopefully, Total's projections for LNG demand are correct, because it is making a very big bet on it.
Staying the course
Even though oil and gas prices have remained stubbornly low all year and there are few signs that a price recovery will happen anytime soon. Total still plans on sticking to its capital expenditure forecasts for the next few years, as described by de la Chevardiere:
The guidance we gave you, the $17 billion to $19 billion by 2017 and onward, was given under the current cost structure. It is true if we were to face further deflation, which as of today, I have no idea, but if we were to face further deflation, we could revise this guidance in the future. But we are not yet ready to do so, not at all, and we do maintain our guidance of $23 billion, $24 billion CapEx for this year; $20 billion, $21 billion for 2016; and then $17 billion to $19 billion by 2017 and onward.
In this case, deflation is any savings the company could capture from things like lower services contract rates. So, basically, all of the current projects in this two- to three-year time horizon will continue as scheduled, and if the company can get some better-than-budgeted contract rates, then all the better.
Benefit from Iran reentering the market?
One of the factors that has many energy investors worried over the next year or so is Iran ramping up production following the most recent nuclear agreement, and prices will continue to drop as a result. Total, though, sees some opportunity here when sanctions are officially lifted. According to de la Chevardiere:
On Iran, the main answer from me is that we will be able to move to Iran when the sanction will be lifted. They are not lifted at the moment. So we are prevented to make any project at the moment in Iran. It is true that we are interested in this oil country. If you will remember, prior sanction were implemented, we had an LNG project in Iran, South Pars. We are still ready to discuss this project among others with the Iranese [sp], but the main issue is that we need to see the sanction being lifted.
Iran has a vast wealth of natural gas and oil reservoirs that have been underutilized for many years because of economic sanctions, but Total was one of the major players in the country pre-sanction. So don't be surprised if Total were to secure some large contracts to work in Iran when the opportunity is available.