This Energy Stock Is Undervalued
Shas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The oil and gas industry in the U.S. has some of the world’s biggest names like ExxonMobil (NYSE: XOM) and Chevron (NYSE: CVX). These two stocks have good long-term growth prospects. However, in this post, I am going to discuss about Total (NYSE: TOT), a European oil giant and the third largest stock on the ADR index list.
It is not just another player in this sector; it is shareholder friendly and is trading at a comparatively low price. For income and value investors, if you are looking for profits in the oil and gas sector, Total is the stock to buy. Let me explain why.
Total is a diversified player in the oil and gas industry. It has both upstream and downstream operations in some of the fastest growing oil/gas producing regions in the world. The company manages its risk efficiently by diversifying its exposure in different regions. For example, it has an above-average industry exposure to faster growing oil producing regions and minimal exposure to the well-established regions of North America and North Sea.
This unique business strategy of Total makes it a safe player in this rather volatile industry. It also maintains the asset quality and avoids any sunk cost. The money invested in fast-growing regions can bring in the cash flows quite fast, keeping the balance sheet in a better condition.
Total has a market cap of $106 billion. The oil and gas industry is a capital intensive industry and is generally measured by the enterprise value (EV) to EBITDA ratio because it factors in the debt requirements of the sector. The EV/EBITDA ratio of Total is 2.88, indicating that it has effectively utilized its operations and has not taken too much leverage. Even though its debt is $43 billion, it is manageable. The debt to equity ratio (D/E) is around 45, which isn't low.
However, if I look at Total's operating cash flow, it is $27 billion, which means the company will generate enough to pay the interest without taking significant hit on earnings. The free cash flow is $1.55 billion, which means there is enough liquidity for the company to manage its high debt. In addition to the low debt, the cash component of Total stands at $18 billion, which helps in making acquisitions and explore more oil blocks in different continents.
Low P/E and attractive dividend yield
If I look at the P/E ratio of Total, the stock is trading cheap at just 7 times 2013 projected earnings. Cheap stocks are not always valuable. But in case of Total, that is not the case. The price to book (P/B) ratio is 1.11 compared to the industry’s 1.7, which means it is valued less than its net worth. Total has an attractive dividend yield of 5.7%, and has historically provided a decent return to investors.
ExxonMobil has a higher P/E of 9.2, which makes me believe that it is trading at a fair price. Looking at the stock performance, Exxon has fared better than Total, gaining 50% since 2005. The reason might be attributed to the consistent growth profile that Exxon offers. It has increased its EPS by 64% in the last seven years. The dividend yield is about half of Total.
However, if we take into the account the share repurchases that Exxon makes every year, the total yield can reach closer to that of Total. In numbers, the 5% share purchase of Exxon every year leads to a total yield of 7.5%, coming very close to Total’s dividend yield. To sum up, Total is a cash cow and a value player with a moderate growth whereas Exxon is a long-term growth player.
Chevron is a $233 billion company and operates in both upstream and downstream segments. Apart from oil, it also engages in coal and molybdenum mining. The dividend yield is 3% and EPS is $13.32. But, like Exxon, it fares better than Total in terms of growth profile. With a huge cash component of $47 billion, it is set to make large acquisitions which is key to the success of oil companies. The growth profile can also be validated by examining the improved operating and profit margins over the last five years.
The major takeaway of this article is the solid financials of Total and the value that it provides. For dividend and value investors, this stock is the best in the energy sector. Moreover, a strong dollar and the costs related to the North Sea natural gas spill have depressed the stock recently, which provides a good buying opportunity now. I would suggest investors to buy this undervalued energy stock.
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This article is written by Sourav Dutta (B.Tech, Information Technology, MM, Paris, MBA in Finance, IIFT) and edited by Shas Dey, StockRiters' Editor-in-Chief. Neither StockRiters nor any of its Directors or employees have any position in any stock mentioned. The Motley Fool recommends Chevron and Total SA. (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. Is this post wrong? Click here. Think you can do better? Join us and write your own!