Vermillion Energy- the Safest Play in the Canadian Oil Patch
Vermillion Energy( VET- TSX, NYSE) is an integrated oil and gas company that operates in Canada, the USA, Netherlands, Germany, France, Britain, and the likes of Australia as well. They are one of our top picks for the energy sector in Canada, for investors not overly bullish on oil, yet looking for good sector exposure.
The main reasons we like Vermillion as a safer oil play is their large dividend, access to Brent pricing and better pricing in Canada vs WCS, and their fairly strong balance sheet. All this should make Vermillion rather appealing to Canadian energy investors looking for a more stable ride than the volatile juniors.
Let’s start off with their dividend, currently at 23 cents/share per month, having been raised earlier in the year. at current price, you will be collecting close to an 8% dividend yield, all while the company has been steadily growing production and projects over 100 000 BOE/day. The dividend doesn’t just provide a reward for waiting for production to grow, but also offers a safety net to investors. We don’t see a scenario currently where Vermillion has to cut their dividend, especially in a time where its hard to see oil taking a nosedive with current geopolitical tensions. Their dividend is covered very well by FFO, with Vermillion bringing in $5 a share in 2017, and over $6/share in 2018. This is while paying a dividend of $2.76/share, only less than 50% 2018 FFO. Even on a FCF measure, their expecting close to $2.80/ share, along with over $4 per share in 2019, after much of the necessary Capex is done. Vermilion hasn’t had to lower its dividend since announcing a monthly dividend in 2003. That shows just how the company knows how to manage its cash flows in efficient ways, even when the commodity price takes a hit, like in 2008 or 2015.
Brent Crude Pricing
Next reason we like VET is because it’s one of the only Canadian plays with access to Brent pricing, in addition to not being overly exposed to weak Canadian prices for the likes of WCS and the overall Canadian Crude index. The company has the likes of 30% of its energy receiving European gas and BRENT pricing, which is close to a $10 premium to WTI, at around $76 a barrel, pre-hedging. This isn’t to say Vermillion isn’t exposed to low Canadian prices, with LSB close to a $16 dollar differential to WTI, however when compared to the WCS benchmark, is very good. On a side note, any pickup in Canadian oil differentials via pipeline capacity improving, or anything positive could also act as a tailwind for much of their more depressed pricing, in which the gap looks like it can’t get too much worse from here. To add, the Spartan acquisition we think was a smart one, buying good Canadian assets at relatively no premium, and while the sector has been extremely out of favour.
Finally, the last thing we like is Vermillion balance sheet, a lot stronger when compared to its Canadian peers. Vermillion has roughly 2 billion net debt, manageable however being less than 2x cash flow, and has been accumulated for growth reasons to continue to increase production. Many names in the space are significantly levered, meaning that, yes with a pick up in oil prices and if the pricing gap closes, every extra dollar would make them that much more attractive. However Vermillion isn’t that. This is why we think its a more conservative way to play the oil patch in Canada, as they aren’t at the mercy of the sector, even if it limits their upside should oil run up.
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