French energy company Total S.A. (NYSE: TOT) pumped 2.7 million barrels of oil per day in the first quarter of 2018. That was up 5% year over year, and helped to push its adjusted net income per share up 8%. But here’s the interesting thing: In April it announced plans to buy nearly 75% of Direct Energie, an electric and natural gas utility, for roughly $1.6 billion. Why would an oil company do that?
One of the first things to note about Total is the fact that it handled the energy downturn that started in mid-2014 in relative stride. For example, its long-term debt rose by a huge 30% in 2014 alone, as the company used leverage to support its spending needs at a time when earnings were falling rapidly. However, that only pushed long-term debt to around a third of the company’s capital structure — not an unwieldy figure. And it has trimmed that debt burden every year since the peak despite 2017 earnings that were still around 35% below what they were in 2013, before the energy downturn hit. It also rewarded investors by maintaining its dividend payment through the rough patch, with increases starting again in late 2016.
It wasn’t an easy period, but Total did a good job through what was easily the deepest energy downturn in a very long time. Some of that was related to good luck, since a number of key oil and gas investments came on line during the downturn. But still, management’s decision to take on debt to support its business, and continue to pay dividends, hints at a company that has a long-term focus. Which is why the decision to spend $1.6 billion on electric and gas utility Direct Energie is so interesting.
Not the first move
Total’s gas, renewables, and power division accounted for roughly 4% of revenue in 2017. So buying a utility isn’t a complete change in direction. For example, Total has a controlling stake in SunPower Corporation, a clean energy power company, which it acquired in 2011. Note, too, that Direct Energie’s core operations are in France and Belgium, which will also keep Total’s utility business close to its corporate home. In other words, Total isn’t going too far outside its comfort zone here.
However, Direct Energie’s electric production will increase Total’s production by a huge 50%. Moreover, it will expand Total’s customer base by nearly 75%. This is a big increase in scale for Total, even though its gas, renewables, and power division will likely remain much smaller than its oil business for many years to come.
In addition to the quick jump in scale, the acquisition will also augment Total’s plans to enhance what it calls its “low carbon” business. To put a number on that, in late 2017 Total announced plans to expand its capacity of natural gas and clean energy production to 5 gigawatts in five years (with SunPower’s investments in France playing a notable role in that growth). With the addition of Direct Energie, that number will increase to 10 gigawatts.
The driving force behind Total’s investment here is made clear in the slide below, taken from its 2017 results presentation. The bar on the left shows the breakdown of energy production in 2016, as reported by the International Energy Agency. The bar on right shows the global power agency’s expectations in 2040, assuming the world works to limit carbon emissions over time. Coal is the biggest loser, with a notable loss of market share. That’s to be expected, as it’s easily the dirtiest way to produce energy. However, oil also loses ground, with natural gas, solar and wind, and nuclear all gaining share.
SunPower and now Direct Energie position Total to benefit from this shift toward low-carbon energy sources. While there’s no reason to believe that Total can’t thrive as an oil and natural gas company in the projected environment, it is also clearly hedging its bets by starting to build a division that will benefit from expected shifts in the global power system.
Changing its stripes, slowly
For investors, there are three big takeaways. The first is that Total is still predominantly an oil and gas company, a fact that won’t change for many years. Second, it has taken a long-term view of the world’s power needs and is slowly shifting gears to adjust. Third, although the low-carbon business is relatively small today, it should be monitored closely.
Total is taking a cautious approach in this division, to be sure, but growth is going to pick up notably following the Direct Energie acquisition. And while Total appears to be keeping within its comfort zone, investments outside of the oil and gas business are clearly not core operations today. More than one company has attempted to diversify outside its core and failed. The oil giant has the financial wherewithal to shift gears like this, but that doesn’t mean it will be successful. This isn’t meant to pour cold water on what appears to be a solid long-term move by Total. However, the Direct Energie deal suggests that investors should start paying more attention to this relatively small division because it is quickly becoming more important.
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