This morning Total (TOT) announced its response to the $30 per barrel oil environment we are living in. The company plans to maintain its 35-plus year streak of uninterrupted dividends.
Management took actions to slash its capital spending by nearly 20%, suspend its share repurchases, and double down on its cost-cutting programs.
Source: Total Investor Presentation
Together, these efforts are expected to result in cash savings of $5 billion. Total will still need to borrow around $4 billion to fill the $9 billion shortfall created by the fall in oil prices from its budgeted level of $60 per barrel.
Under this plan, management expects the firm's net debt to capital ratio (excluding leases) will rise from 16.7% at the end of 2019 to about 20%.
Over the weekend, we had downgraded Total's Dividend Safety Score from our lowest Safe rating to Borderline Safe since management had previously emphasized that the company wanted to keep its gearing below 20%. If lease debt was included, Total's gearing was already there in 2019.
It's still unclear how comfortable Total would be increasing its gearing beyond 20% if $30 per barrel oil persists beyond several quarters. Management expressed hope that this price environment isn't sustainable.
Total said that global oil demand is likely to fall by 6 million barrels per day (or about 6%) in April due to the spread of the coronavirus. Meanwhile, Saudi Arabia and its partners are increasing production by 3-4 million barrels per day.
Combined, that's an extra 10 million barrels per day on what Total describes as a "zero-demand" market. That's why oil prices have collapsed to under $30 per barrel.
We plan to maintain our Borderline Safe rating on Total for now since its gearing will be at or above management's target level this year, and no one knows how long this era of depressed oil prices will last.
However, income investors can breathe a little easier, and Total's ongoing commitment to its payout could be a sign of things to come for most of the other oil majors (Exxon, Chevron, and Royal Dutch Shell; BP's payout looks shakiest).
Here's the Dividend Safety Score downgrade note we issued on March 22:
Total's (TOT) dividend has remained the same or risen every year for more than 35 years. In September 2019, management even increased the firm's dividend growth guidance to 5% to 6% per year.
However, the plunge in oil prices this month has potential to change that plan. Saudi Arabia engaged Russia in a price war for market share, sending Brent oil falling from about $50 per barrel to around $30 today.
We believe that the price of oil could remain very weak for at least a few quarters, if not for more than a year.
The good news is that Total expects to be able to cover its organic capital expenditures at an oil price below $25 per barrel, down from around $100 in 2014.
Source: Total Investor Presentation
Last year, Brent oil prices averaged $64 per barrel and Total generated $26.4 billion in cash flow from operations (CFFO), excluding working capital fluctuations.
That covered $17.4 billion of capital investments and the $7.5 billion dividend while also providing room for some buybacks.
However, management has said that Total's profits fluctuate $3.3 billion for every $10 per barrel change in realized price.
In other words, if oil stays near $35 per barrel this year, Total's CFFO could fall by about $10 billion to sit near $16.5 billion.
Prior to the crash in oil, management targeted annual capital expenditures (net of acquisition and divestitures) between $16 billion and $18 billion.
While some of this spending could possibly be reduced in this environment, in the past Total has emphasized that investing in its business remains an important priority.
The bottom line is that it's hard to imagine Total having much, if any, free cash flow available for its $7.5 billion dividend if this environment persists.
To temporarily fill the hole until prices hopefully recover, management would need to take on debt and possibly divest more non-core assets, which could be challenging with oil prices so low.
Unfortunately, taking on debt could also be problematic given Total's priorities. Unlike Chevron and Exxon, which maintain low net debt to equity ratios (i.e. gearing) and appear comfortable bringing up their leverage above 20%, Total has said that keeping gearing below 20% is a priority.
Gearing measures the proportion of a company's financing that is from debt (net of cash) rather than equity. Most of Total's investment grade-rated peers have gearing closer to 20% or as high as 30%.
As you can see, if lease debt is included, then Total's gearing in 2019 was right at management's 20% target. If leases are excluded, then Total's gearing is second lowest compared to its major peers (blue bars on the right).
Source: Total Investor Presentation
We estimate that borrowing to pay the $7.5 billion dividend would push Total's gearing to nearly 25%. Without leases, gearing would rise to about 21%.
Management has said that "we need absolutely to have this low gearing under 20%." The company also desires to maintain its A+ credit rating from S&P, so it's unclear how willing Total would be to take on higher debt to continue its dividend track record.
Source: Total Investor Presentation
Overall, Total has a solid balance sheet and has previously demonstrated a strong commitment to its dividend.
However, with oil prices near $30 per barrel, that commitment could be tested, especially since management previously seemed unwilling to take the firm's gearing higher than its current level. Therefore, we are downgrading Total's Dividend Safety Score to Borderline Safe.
