by Ben Strubel of Strubel Investment Management

Investing in companies that pay above average dividends has historically been a good investment strategy. Of course investors, specifically those looking for income, are looking for more than just a current high dividend yield they also want the company to be able to continue to pay out that high dividend and hopefully increase it as well.

A recent study by Tweedy Browne (the dividend studies begin on page 30) sheds some light on what investors might want to look for in addition to just a high yield. The historical study shows that investors can increase their returns by narrowing down the list of stocks with high dividend yields to those that also have low dividend payout ratios. One company that meets both criteria is TOTAL S.A. (TOT).

TOTAL is a French vertically integrated oil and gas company. It is the second smallest of the six “supermajors.” The other five supermajors are ExxonMobil (XOM), Royal Dutch Shell (RDS.A), Chevron (CVX), BP (BP), and ConocoPhillips (COP).

Vertically integrated oil & gas companies such as TOTAL (and the other supermajors) generally divide their businesses in to three parts: upstream, downstream, and chemicals.  Some companies break out power generation, transport, or alternative energy assets into different business units as well; however, these assets usually comprise a small portion of the company’s overall assets and in most cases don’t materially affect the valuation comparisons that we will examine.

Business Overview

TOTAL S.A. divides its business into three parts: upstream, downstream, and chemicals.

Upstream (60% of Assets, €12,858M Operating Income)
Upstream activities consist of exploration and production (E&P) as well as the gas and power divisions. TOTAL has exploration operations in more than 40 countries and production operations in 30. The gas and power division conducts downstream activities related to natural gas, liquefied natural gas (LNG), and liquefied petroleum gas (LPG). The upstream division also includes power generation and trading activities.

Downstream (24% of Assets, €2,237M Operating Income)
TOTAL’s downstream division contains its refining and marketing operations as well as the trading and shipping divisions. The refining operations consist of interest in 24 refineries with a total refining capacity of 2594 KBD (thousands of barrels of oil equivalent per day). Marketing operations span 150 countries and include approximately 16,200 service stations located primarily in Europe as their largest assets. Together, TOT’s sales of refined products average 2641 KBD. The trading and shipping division is responsible for buying and selling crude and refined products and supporting the transportation of those products to and from internal company divisions or external customers.

Chemicals (10% of Assets, €553M Operating Income)
The chemicals division consists of base chemicals (petrochemicals and fertilizers) and specialty chemicals (rubber processing, resins, adhesives, and electroplating).

When comparing TOTAL to its peers, we will be using ExxonMobil, Royal Dutch Shell, Chevron, and ConocoPhillips. BP was excluded from all comparisons because of the Macondo oil spill and its subsequent affect on BP’s valuation.

Because the integrated oil and gas companies are largely in a commodity business, investors should favor the most efficient producer and pay the lowest price for a company’s assets. We believe that paying the lowest price for a producer’s assets is paramount. While efficiency is important, it is something that can be improved over time by management. You never get a chance to improve the price you pay for assets. Indeed, within industries things like returns on capital, margins, and even growth rates show strong tendencies toward mean reversion. In many of these measures, TOTAL has advantages over its competitors.


First, let’s look at TOTAL’s assets and how much investors are paying for those assets.

Exploration and Production (Upstream)

TOTAL has 10,483 Mboe (millions of barrels of oil equivalents) of proved reserves. Roughly 60% of TOT’s assets are accounted for in the upstream segment. We used assets rather than measures of income or cash flow because of the year-to-year volatility in refining margins. With a total market cap of $119B we can estimate that investors are assigning a value of $71.4B ($119B times 60%) or about $6,800 per Mboe to TOT’s reserves. In comparison investors are paying an average of $8,900 (on an asset weighted basis) per Mboe for the proven reserves of the other supermajors.

While proven reserves are important, investors also need to take into account production rates and production costs. After all, reserves in expensive locations are less valuable than reserves in locations that are easy and cheap to access.

In respect to production costs, TOT has some of the lowest in the industry with costs averaging $5.46 per boe (barrel of oil equivalent) compared to an industry average (excluding RDS) of $7.05. The low production costs are generally a function of the location of TOTAL’s upstream assets. Africa, Asia, and the Middle East have very low production costs compared to Europe and the Americas. In 2009, TOTAL got 63% of its production from Africa, Asia, and the Middle East. The company also has 69% of its proven reserves in those areas.

One measure of future profitability is production and reserves per net well. The more productive a well is the higher the margin and the more profitable the well will be for the owner. TOT has the most productive wells among its peers with average reserves of 4.25 Mboe per net productive well and average production of .92 KBD per net productive well. For comparison purposes, the peer group averages .61 Mboe of proved reserves per net productive well and .12 KBD of production per net productive well.

Buying proved reserves and production capacity at cheap prices is all well and good if that capacity never needs to be replaced. But it does. Thus reserve replacement rates and expenses are important to look at when valuing TOTAL. Here TOTAL falls short of other competitors.

Over the past three years TOTAL added an average of 747 Mboe to its reserves through new finds, revisions on existing finds, improved recovery methods, and purchases of existing minerals. The average cost for these reserve additions was $3.96 per boe compared to the industry average finding cost of $3.07. But this doesn’t tell the whole story. Over the last three years ExxonMobil has been expanding its reserves far more cheaply than any other supermajor. ExxonMobil brings the average down substantially. ExxonMobil has the lowest finding costs, followed by Chevron. TOTAL is in the middle at third. Royal Dutch Shell and ConocoPhillips’ finding costs are more expensive than TOTAL’s.

Overall, in the last five years, the E&P cash margins for TOTAL have been in the middle of the pack as shown below.

While the E&P division has remained profitable, the recession has had an effect with ROACE (Return on Average Capital Employed) falling from 34% in 2007 to 18% in 2009.


Downstream assets comprise 24% of TOTAL’s assets. On an asset weighted basis, we can assume that investors are valuing TOTAL’s downstream operations at $28.56B ($119B times 24%). Much like its upstream assets, investors are again paying a very cheap price for TOTAL’s downstream assets.

Refining Capacity
TOTAL has a refining capacity of 2,594 KBD so investors are paying roughly $11,000 per KBD of refining capacity. Only ConocoPhillips downstream refining operations are priced cheaper on an asset weighted basis.

Refined Product Sales
TOTAL also had sales of 3616 KBD of refined products, primarily through its network of service stations. Again on an asset weighted basis investors are paying a low price for refined product sales. Investors are paying approximately $7.9M per KBD of refined product sales. This is well below the average of $10.5M per KBD of refined product sales for the other four supermajors we examined.

There are however a few reasons that TOTAL’s downstream assets are cheap. The first is that there is currently a worldwide surplus of refining capacity and margins have fallen significantly, even turning negative in 2009. As such ROACE (Return on Average Capital Employed) has declined from 21% to 20% to 7%.

The second reason is that a majority of TOTAL’s refining capacity and refined product sales are in Europe where demand is weak. All of TOTAL’s wholly owned refineries (totaling 85% of TOTAL’s total capacity) are located in Western Europe with the exception of one in Texas. The remaining 15% of total refining capacity is spread throughout Asia, Africa, and the Middle East in minority interest in other refineries.

(Source: TOTAL’s 2009 20-F)

According to Ernst & Young’s Oil and Gas Review, demand remains weak in Europe (particularly Western Europe) and North America. Asia, Africa, and the Middle East are showing the most demand for refined products.


The chemicals portion is TOTAL’s smallest business unit by assets, and its profitability is closely tied to that of the refining business. Both ExxonMobil and Royal Dutch Shell have chemicals businesses similar in size to TOTAL’s. Chevron and ConocoPhillips have much smaller chemicals businesses, mainly in the form of CPChem, a joint venture between the two.

Just like in the refining segment, margins and sales have fallen in the chemicals segment due to the recession. ROACE has declined from 12% in 2007 to 9% in 2008 to 4% in 2009.

The one bright spot for TOTAL investors is that they are paying a much lower price for TOTAL’s chemical manufacturing assets than either RDS or XOM. TOTAL has a chemicals capacity of 18.9 million metric tons (MMT) of which 11.1 MMT are simple base chemicals and 7.8 MMT are more complex first derivative chemicals. At 10% of assets, investors are valuing the chemical division at roughly $11.9B or approximately $630 per metric ton of chemicals manufacturing capacity. Compare this to the average market valuation for RDS and XOM of $1,600 per metric ton of capacity (all three companies produce base and first derivative chemicals in roughly the same proportions).

Reasons for Caution

Shift to National Oil Companies (NOCs)
There has been a continuing shift in the balance of power between investor-owned oil companies and national oil companies. Roughly 75% of world’s oil reserves are controlled by NOCs. Previously, NOCs were usually forced to do business with the supermajors, as only they had the technical knowhow to develop the resources in some countries. Now we are beginning to see NOCs develop this capability themselves or partner with each other to develop finds. While the supermajors will still play an important role, that role may be diminished.

A perfect example of the threat the supermajors face in taking a backseat to NOCs is what happened in 2007 in Venezuela. ConocoPhillips and ExxonMobil had acreage and assets in Venezuela that were expropriated after they refused to comply with government demands. TOTAL received payment for assets that were transferred to state-run companies and still has some assets in Venezuela.

TOTAL has an advantage in that it is a French oil company, and France has traditionally not been viewed as negatively as the United States or Britain by some leaders hostile to those countries. TOTAL does not have any aversion to doing business with such upstanding global citizens as Iran (3rd in the world in reserves), Libya (9th), and Myanmar (76th).

Unfunded Pension Liabilities
One other thing investors should be aware of is that TOTAL currently has €1,883 in unfunded pension liabilities. But pension plan assumptions are reasonable, as they assume a 6.14% expected return on pension assets.


TOTAL S.A. currently trades at around €42 or $55 with a dividend yield of approximately 5.3%. Using a Dividend Growth Model and an 11% discount rate gives us an implied dividend growth rate of approximately 5.5%. Over the past seven years, we can see TOTAL’s dividend has increased by 7.77% percent. But over the past three years, due to the global recession, the dividend has been flat.


It’s easy to see why Tweedy Browne has made TOTAL S.A. the fifth largest holding in it dividend fund. TOTAL has very productive assets, namely, access to low cost reserves and production capacity, which are available at cheap prices. While those assets aren’t being used in the most effective manner, TOTAL’s margins are around the middle of the peer group. In a commodity business, management can always be improved, but the price investors pay for refining capacity, proved reserves, and productive wells can’t be improved once they are bought. TOTAL does pay an attractive dividend that the market currently prices for mid-single-digit growth. With TOTAL’s assets and an improving global economy, it wouldn’t be surprising to see the dividend grow faster than the market anticipates.

Disclosure: No positions