We see Vermilion Energy Inc. (TSX: VET) as an attractive opportunity for those willing to get paid to wait
SmallCapPower | July 21, 2017: Vermilion Energy Inc. (TSX: VET) shares have been trending lower over the past few months in sync with the falling oil prices and currently trades at ~$39 as on July 18, 2017. Based in Calgary, Alberta, Vermilion Energy is an international oil and gas producer with superior operational and financial metrics. At the current market price, the stock has a high dividend yield of ~6.0% and if oil prices move up, there should also be decent capital appreciation. The Company’s reserves and production continues to grow via organic efforts and selective M&A. As and when crude prices start their next sustained up move, the operating and financials metrics of Vermilion Energy would improve significantly.
WTI and Vermilion Energy share prices
Investment thesis
- Vermilion Energy is an international oil and gas producer with superior operating and financial metrics
- Industry leading dividend yield of over 6.0%
- Up move in crude prices should drive the next leg of uptrend in the share price of Vermilion Energy
Robust operating model
Vermilion Energy is an international E&P company that holds conventional/semi-conventional assets with high rates of return, low decline rates and strong capital efficiencies. The Company holds a diversified project inventory and currently has 10 major drilling projects across the U.S., Canada, and Europe with a net drilling inventory of nearly 1,200.
Key drilling projects of Vermilion
Operational efficiencies have been improving steadily over the past few years, which to an extent was necessary for its survival in the 2014 oil price collapse. OPEX witnessed a 27% reduction over 2012-2016 while 2P F&D costs (capex) declined 84% over the period 2011-2016, reaching $5/BOE in 2016. Vermilion Energy boasts one of the best netbacks in the industry and ranks behind Raging River Exploration Inc (TSX: RRX) ($40/BOE) with a $34/BOE.
Continued improvement in operational and capital efficiencies
Strong FFO and FCF aid regular dividend payouts
Owing to its operational efficiency and strong production growth, Vermilion Energy generates consistently high funds from operations (FFO) and free cash flows (FCF) that have aided it in rewarding shareholders with regular dividends. In 2016, Vermilion Energy generated more than $500 million in FFO and nearly $300 million in FCF. The Company has paid a monthly dividend of ~$0.20 over the past three years. On July 17, 2017, Vermilion Energy announced a dividend of $0.215 per share, or $2.60 annualized, which translates into a forward dividend yield of 6.6%. This is higher than its peer average dividend yield of ~4%.
Potential for capital appreciation on a recovery in crude prices
In addition to the high dividend yield, an uptick in crude prices could also result in significant appreciation in its stock price. Both WTI and Brent prices have been on an upward trend since early 2016 and currently trade at US$46/barrel, up nearly 10% from the June 21st low of US$42.50. With production expected to ramp up ~10% in 2017, rising crude prices could result in significant revenue increases along with strong operating and net margins. A the same time, Vermilion Energy could also withstand any sharp fall in crude prices from current levels as the WTI breakeven for VET is only at ~US$15/barrel compared to the peer average of US$50/barrel.
Financial analysis
1Q17 performance beats consensus: VET’s revenues beat the consensus estimate of $237 million and more than doubled to $245.4 million in 1Q17 from $163.4 million in the prior year quarter, due primarily to higher commodity prices which, on average, increased more than 50% YoY. Fund flows from operations increased 53% YoY to $143.4 million for the quarter while net income came in at $44.5 million, or $0.38 per share, (much higher than the Street’s $0.01) compared to a net loss of $85.8 million, or $0.76 per share, in 1Q16.
Source: Company filings
Outlook and guidance
Vermilion Energy is guiding for a production increase of 10% in 2017 to 70,000 boe/d and 9% in 2018 to 76,000 boe/d, with capex of $295 million and $340 million. We note that the capex guidance is less than the three-year average of $476 million, which should result in higher earnings in 2017. The Company’s guidance for FFO for 2017 and 2018 based on the WTI price of US$45.6 and Brent price of US$47.4 is roughly $600 million while FCF is forecast at ~290 million for 2017 and $270 million for 2018. If the prices were to go up to US$60 for WTI, FFO would increase to ~$670 million. Hence strong fundamental outlook, high dividend yield and recent share price correction present an attractive entry point for investing into shares of Vermilion Energy.
Disclosure: Neither the author nor any of the principals at Small Cap Power, or their family members, own shares in any of the companies mentioned above.
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