The Good And Bad: TotalEnergies SE & Trinity Industries

the-good-and-bad:-totalenergies-se-&-trinity-industries

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Eight new stocks made our Most Attractive list this month, while 12 new stocks joined the Most Dangerous list.

October Performance Recap

The Most Attractive Stocks (+4.7%) outperformed the S&P 500 (+1.9%) from October 5, 2022 through November 1, 2022 by 2.8%. The best performing large cap stock gained 20% and the best performing small cap stock was up 24%. Overall, 25 out of the 40 Most Attractive stocks outperformed the S&P 500.

The Most Dangerous Stocks (+6.9%) underperformed the S&P 500 (+1.9%) as a short portfolio from October 5, 2022 through November 1, 2022 by 5.0%. The best performing large cap short stock fell by 12% and the best performing small cap short stock fell by 10%. Overall, 13 out of the 35 Most Dangerous stocks outperformed the S&P 500 as shorts.

The Most Attractive/Most Dangerous Model Portfolios underperformed as an equal-weighted long/short portfolio by 2.2%.

The Most Attractive stocks have high and rising returns on invested capital (ROIC) and low price to economic book value ratios. Most Dangerous stocks have misleading earnings and long growth appreciation periods implied by their market valuations.

Most Attractive Stocks Feature for November: TotalEnergies SE

TotalEnergies is the featured stock from November’s Most Attractive Stocks Model Portfolio. I made TTE a Long Idea on May 25, 2022. Since then, the stock is down 2% compared to a 1% decline for the S&P 500.

TotalEnergies has grown net operating profit after-tax (NOPAT) by 30% compounded annually since 2016. At $31.5 billion, the company’s TTM NOPAT is 2.6x its average NOPAT from 2012–2021. TotalEnergies’ NOPAT margin has increased from 5% in 2016 to 12% over the trailing-twelve-months (TTM), while invested capital turns rose from 0.9 to 1.2 over the same time. Rising NOPAT margins and invested capital turns drive TotalEnergies’ return on invested capital (ROIC) from 4% in 2016 to 14% over the TTM.

Figure 1: NOPAT Since 2016

TTE Rising NOPAT

New Constructs, LLC

TotalEnergies Is Undervalued

At its current price of $59/share, TTE has a price-to-economic book value (PEBV) ratio of 0.3. This ratio means the market expects TotalEnergies’ NOPAT to permanently decline by 70%. This expectation seems overly pessimistic for a company that has grown NOPAT by 30% compounded annually since 2016.

Even if TotalEnergies’ NOPAT margin falls to its five-year average of 7% (vs. 12% TTM) and revenue falls 1% compounded annually for the next decade, the stock would be worth $75+/share today – a 27% upside. In this scenario, TotalEnergies’ NOPAT would fall 4% compounded annually for the next 10 years. See the math behind this reverse DCF scenario. Should TotalEnergies grow profits more in line with historical levels, the stock has even more upside.

Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology

Below are specifics on the adjustments I made based on Robo-Analyst findings in TotalEnergies’ 6-Ks and 20-Fs:

Income Statement: I made $9.3 billion in adjustments, with a net effect of removing $4.2 billion in non-operating expenses (2% of revenue).

Balance Sheet: I made $97.0 billion in adjustments to calculate invested capital with a net increase of $22.2 billion. One of the most notable adjustments was $30.3 billion in asset write-downs. This adjustment represents 15% of reported net assets.

Valuation: I made $117.3 billion of adjustments, with a net decrease to shareholder value of $41.7 billion. Apart from total debt, the most notable adjustment to shareholder value was $37.5 billion in excess cash. This adjustment represents 26% of TotalEnergies’ market cap.

Most Dangerous Stocks Feature: Trinity Industries TRN

Trinity Industries, Inc. (TRN) is the featured stock from November’s Most Dangerous Stocks Model Portfolio.

Trinity Industries’ economic earnings, the true cash flows of the business, have fallen from $467 million in 2015 to -$298 million over the TTM. Over the same time, Trinity Industries’ NOPAT margin has fallen from 13% to 6%, while invested capital turns fell from 0.8 to 0.2. Falling NOPAT margins and invested capital turns drive Trinity Industries’ ROIC from 10% in 2015 to 1% over the TTM.

Figure 2: Economic Earnings Since 2015

TRN Economic Earnings

New Constructs, LLC

Trinity Industries Provides Poor Risk/Reward

Despite its poor fundamentals, Trinity Industries’ stock is priced for significant profit growth, and I believe the stock is overvalued.

To justify its current price of $30/share, Trinity Industries must improve its NOPAT margin to 10% (compared to 6% in the TTM) and grow revenue by 13% compounded annually for the next ten years. See the math behind this reverse DCF scenario. In this scenario, Trinity Industries’ NOPAT would grow 15% compounded annually for the next decade. Given that Trinity Industries’ NOPAT has fallen 27% compounded annually since 2015, I think these expectations are overly optimistic.

Even if Trinity Industries can improve its NOPAT margin to 9% (five-year average) and grow revenue by 11% compounded annually for the next decade, the stock would be worth no more than $5/share today – an 83% downside to the current stock price. See the math behind this reverse DCF scenario.

Each of these scenarios also assumes Trinity Industries can grow revenue, NOPAT, and FCF without increasing working capital or fixed assets. This assumption is unlikely but allows me to create truly best-case scenarios that demonstrate how high expectations embedded in the current valuation are.

Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology

Below are specifics on the adjustments I made based on Robo-Analyst findings in Trinity Industries’ 10-Qs and 10-Ks:

Income Statement: I made $463 million in adjustments, with a net effect of removing $48 million in non-operating income (3% of revenue).

Balance Sheet: I made $3.2 billion in adjustments to calculate invested capital with a net increase of $831 million. One of the most notable adjustments was $2.2 billion in deferred tax assets. This adjustment represented 29% of reported net assets.

Valuation: I made $6.7 billion in adjustments, all of which decreased shareholder value. Apart from total debt, the most notable adjustment to shareholder value was $1.1 billion in deferred tax liabilities. This adjustment represents 48% of Trinity Industries’ market cap.

Disclosure: David Trainer, Kyle Guske II, Matt Shuler, and Italo Mendonça receive no compensation to write about any specific stock, style, or theme.

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