OREANDA-NEWS. Fitch Ratings has revised Total SA's Outlook to Negative from Stable and affirmed its Long-term Issuer Default Rating (IDR) at 'AA-'. The agency has also assigned an 'A' rating to the company's EUR5bn subordinated notes. A full list of rating actions is available at the end of this commentary.

The Outlook revision reflects our expectation that weak oil prices will result in Total's financial leverage being higher than we previously assumed. We now expect Total's funds from operations (FFO) net leverage to peak at around 2.7x in 2016 and to average 1.9x in 2017-19, close to our 2x negative rating action guidance. We lowered our price deck in February 2016 and forecast Brent to average USD35 per barrel (bbl) in 2016, before gradually recovering to USD45/bbl in 2017, USD55/bbl in 2018 and USD65/bbl in the long-term.

The 'AA-' IDR reflects the company's strong business profile with diversified upstream and downstream operations, financial flexibility enhanced by its scrip dividend programme, sound liquidity and falling capital intensity. Over the next two years the ratings will be largely driven by Total's ability to balance its cash inflows and outflows amid weak oil prices.

Total is a major integrated oil and gas (O&G) company with 2015 production of 1.79 million barrels of oil equivalent per day (MMbpd) (excluding equity affiliates) and EBITDAX (EBITDA before exploration charges) of USD22.4bn. It has strong positions in deepwater offshore and LNG production. Total's operating cash flows are supported by downstream and trading activities amid low oil prices.

KEY RATING DRIVERS
Weak Oil Prices Response
In 2015, Total's EBITDAX decreased 27% yoy to USD22.4bn as Brent collapsed 47% to USD53/bbl. We expect the company's 2016 EBITDAX to drop further on lower oil prices and projected weaker refining margins before gradually recovering in 2017. On the other hand, we assume that cost deflation and opex rationalisation will support Total's operating cash flows in the depressed oil price environment. This includes renegotiations with suppliers and service providers, headcount reduction in upstream and other similar cost-saving measures.

In 2016, Total announced its plans to reduce capex to USD19bn in 2016 and to USD17bn-USD19bn in 2017, from USD23bn in 2015 and USD26.4bn in 2014. In addition, the company has made a commitment to reduce operating expenses by more than USD3bn per year up to 2017, after having achieved USD1.5bn savings in 2015. We believe that in a deflationary cost environment these cuts are moderate compared with those announced by more upstream-focused US companies, and should allow Total to maintain at least stable production through the cycle.

We also view positively the company's scrip dividend programme with a 10% incentive, which allowed Total to reduce its cash dividends by 61% in 2015. We assume the scrip dividend programme will remain in place in 2016-17.

We believe that under our price deck assumptions Total would remain free cash flow (FCF)-negative (after dividends) over the next two years, but we expect the shortfall to be moderate and manageable. An inability to at least keep its FCF shortfall at a minimum could result in a downgrade.

Strong Upstream Operations
We view Total's operational profile as strong. Its new large upstream projects, such as CLOV in Angola, West Franklin in the UK and Eldfisk in Norway, have contributed to production growth in 2015 and helped reverse the negative production trend observed in 2011-14.

In 2015 Total's upstream production (without equity affiliates) increased 13.5% yoy, the largest among its European peers. The significant production growth supported the company's earnings: in 2015 its normalised EBITDAX decreased 31% yoy, compared with Shell's -41% and BP's -39%.

Total targets an upstream production growth of 5% p.a. on average in 2014-19, including production from equity affiliates. Our analysis concentrates more on consolidated production excluding equity affiliates (which can grow slower) and we believe the company's target may prove challenging in the depressed oil price environment. We therefore assume slower production growth of 3% yoy in 2016, 1% in 2017 and flat thereafter.

Downstream Margins to Moderate
In 2015 Total's earnings were supported by strong refining margins in Europe. Cumulative EBITDA at its refining & chemicals and marketing & services divisions increased 42% yoy, while EBITDA at the upstream division collapsed 47%.

We expect refining margins to moderate in 2016 as overcapacity, structural imbalances and exposure to overseas competition continue to dominate the European downstream industry over the medium term. However, the company's midstream and downstream businesses will remain an important stabilising factor in the weak oil price environment.

Competition, Prices Threaten Disposals
We view positively Total's ability to raise cash through disposals when needed. Total received USD8.7bn from disposals in 2014-15. It has announced a USD10bn disposal programme for 2015-17, including sales of USD4bn already agreed.

However, numerous disposals may weaken Total operationally, especially if proceeds are paid out as dividends rather than re-invested or used to reduce debt. In addition, with many O&G companies seeking to divest their assets simultaneously there is a risk that assets will not be sold, or will fetch far lower prices than planned. We conservatively assume that Total's net disposal proceeds will reach USD4bn in 2016, ie, mainly proceeds from asset sales already agreed, USD2bn in 2017 and USD1.5bn in 2018-19.

KEY ASSUMPTIONS
- Fitch's Brent price deck: USD35/bbl in 2016, USD45/bbl in 2017, USD55/bbl in 2018 and USD65/bbl in the long term
- Northwest European refining margin to fall from USD7.2/bbl in 2015 to USD5.5 in 2016 and USD5 in the long term
- Moderately rising upstream production (excluding equity affiliates): 3% yoy in 2016 and 1% in 2017 and flat thereafter
- Capex marginally below the company's guidance: USD18bn in 2016 (guidance: USD19bn), USD16.5bn in 2017 (guidance: USD17bn-USD19bn), USD17bn in 2018 and USD18bn in 2019
- Cash dividends: USD3bn p.a. in 2016-17 (assuming the scrip programme remains in place); USD7bn p.a. in 2018-19
- Net cash receipt from disposal: USD9bn in 2016-19; enterprise value/EBITDA: 10x
- EUR5bn hybrid bonds issued in February 2015 treated as 50% equity / 50% debt
- Operating lease charges capitalised using an 8x multiple

RATING SENSITIVITIES
Negative: Future developments that could lead to a downgrade include:
- Falling upstream production (excluding equity affiliates) vs. 2015
- FFO adjusted net leverage above 2x on a sustained basis (2016F: 2.8x; 2017-19F: 1.9x)
- Inability to balance cash inflows and outflows in 2016-17 and consistently negative FCF after disposals
- Excessive capex cuts weakening the company's operational profile
- Significant growth in the amount of completion guarantees issued by the company, call on issued guarantees or rising completion risks associated with non-consolidated projects

Positive: Future developments that could lead to the Outlook being revised to Stable:
- Neutral or positive FCF on a sustained basis
- FFO adjusted net leverage comfortably within the 1.5x-2x range in 2017-19
- Consistently rising or stable upstream production

Positive: Future developments that could lead to an upgrade:
- Positive FCF on a sustained basis
- FFO adjusted net leverage consistently below 1.5x through the cycle
- Consistently rising upstream production

LIQUIDITY AND DEBT STRUCTURE
Strong Liquidity, Balanced Repayments
At end-2015 Total's short-term debt of USD12.5bn and Fitch-forecasted negative FCF in 2015 were fully covered by USD23.3bn in cash. Total has healthy access to international debt markets and should be able to refinance upcoming maturities when needed. Total's debt is mainly made up of bonds and its maturities are well-balanced.

Hybrid Bonds Rated 'A'
We rate Total's USD5bn deeply subordinated bonds issued in February 2015 two notches below Total's IDR in line with Fitch's Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (November 2014). The bonds are perpetual and have no event of default. Total has the option to defer the coupon on a cumulative basis. We assume a 50% equity credit for the bond according to our criteria.

Off-Balance Sheet Debt
At end-2014 Total's guarantees issued against borrowings of its non-consolidated affiliates amounted to USD10.2bn. This figure mainly relates to completion guarantees and similar arrangements issued in connection with Total's largest non-consolidated projects, including the Jubail refinery and the Ichthys LNG. We believe that the possibility of large cash outflows associated with these guarantees is remote, and therefore exclude them from Total's adjusted debt, with the exception of the USD5bn guarantees related to Ichthys LNG (50% of which we add to Total's adjusted debt). This is in view of the project's complexity and completion risks.

In a stress case scenario where all such guarantees are triggered Total's net leverage would rise to 2.2x in 2017-19 from 1.9x, a level inconsistent with the 'AA' category but still manageable, especially taking into account Total's ample liquidity. However, further growth of off-balance sheet guarantees may weigh on Total's rating, especially if they are provided to projects with high completion risks and/or doubtful economics.

FULL LIST OF RATING ACTIONS

Total SA
Long-term IDR: affirmed at 'AA-'; Outlook revised to Negative from Stable
EUR5bn subordinated notes: assigned at 'A'

Total Capital SA
Senior unsecured debt: affirmed at 'AA-'

Total Capital International SA
Senior unsecured debt: affirmed at 'AA-'

Total Capital Canada Ltd.
Senior unsecured debt: affirmed at 'AA-'