Vermillion Energy (NYSE:VET) is a little known mid-cap oil and gas producer that has been flying under the radar. The company rarely receives any coverage from the mainstream financial media, even though Vermillion is a well-established company with a market cap of almost $5 billion that has been operating for decades. I suggest investors, particularly income seeking investors, should take a closer look at this stock.
Vermilion is a Calgary, Alberta-based exploration and production company that is engaged in oil and gas production from its properties in Canada, Europe and Australia. At the end of last year, the company had 260.9 million barrels of oil equivalent reserves, which were 42% natural gas and 58% liquids. Vermilion mainly holds conventional and semi-conventional assets. Almost 47% of the company's reserves were located in Canada, 24% in France, 10% in Ireland, 7% in Australia and the rest were in Netherlands, Germany and the US. The company expects to produce up to 63,500 barrels of oil equivalents per day in 2016, which will be 48% liquids and 52% natural gas, as per the official guidance. Almost 40% of this year's production is expected to come from Canada, 19% from France, 13% each from Ireland and Netherlands while the remaining will come from Germany and the US. The company's operations and reserve base, therefore, are located in developed countries. This minimizes operational risks.
But what I really like about Vermilion is its dividend. The company started paying dividends in 2003, and has never decreased this payout. Even during the downturn, when a number of oil and gas producers were forced to either cut or suspend dividends, Vermilion kept the dividends flat. This makes Vermilion a rare exploration and production company that has never slashed dividends. On top of this, Vermilion offers an attractive yield of 4.6%, which is also rare considering that most US-based small-to-mid-cap independent oil producers offer little to no dividends. Moreover, Vermilion offers monthly dividends, which makes it particularly attractive for those dividend investors who are interested in opening a monthly stream of earnings.
Vermilion, however, like every oil and gas producer, has struggled in the downturn. The company has seen its revenues shrink significantly due to weakness in oil and gas prices. In the first nine months of this year, Vermilion's revenues clocked in at C$583 million, down 11% from last year, while its net loss almost doubled to C$156 million. But thanks to the improvement in oil and gas price environment, the company's losses have been shrinking. In the third quarter, for instance, when the average WTI price was almost $45 a barrel, the company's net loss clocked in at C$14.47 million. That's down from a loss of C$85.8 million in the first quarter when oil averaged around $33 a barrel.
With improvement in commodity prices, the company seems to be quickly moving towards profitability. But what's particularly impressive is that this year, Vermilion has been successful in generating enough cash flows to fully fund its capital expenditure and dividends. That's something which very few oil and gas producers have been able to do. In fact, few major US-based independents like Apache Corp. (NYSE:APA) have just started to generate free cash flows while others, like ConocoPhillips (NYSE:COP) are hoping to report excess cash flows in 2017. Vermilion, on the other hand, has been doing this all year. It's no surprise, therefore, that the company has been able to sustain the dividends in the downturn.
In the first nine months of this year, Vermilion's cash flow from operations were C$349.26 million, which was enough to fully fund the capital expenditure of C$175.53 million, acquisitions of C$19.81 million and cash dividends of C$72.39 million. The company ended the first nine months of 2016 with free cash flows, after accounting for dividends, of C$81.5 million.
Vermilion's ability to generate free cash flows, even in a tough pricing environment, is a result of the company's relentless focus on living within cash flows. In fact, for the last several years, the company has kept its exploration and development expenditure lower than its fund flow from operations (a non-GAAP measure of profitability used by Vermilion). Consequently, the company has historically largely remained free cash flow positive, data from Morningstar shows. That's in stark contrast to the US where most of the independent oil and gas producers, after consistently burning cash flows for years, have only recently begun to focus on free cash flows.
Besides, Vermilion also has a decent financial health. At the end of the third quarter, the company had C$1.31 billion of long-term, which translated into a debt-to-equity ratio of just 54%. That's lower than the industry's average of 67.7%, as per data from Thomson Reuters.
In short, Vermilion is a rare gem in the exploration and production space that gives a monthly dividend, which translates into an annualized yield of 4.6%, generates solid cash flows that fund its entire capital budget as well as dividends and has an under-levered balance sheet. Its future outlook is looking even better.
That's because firstly, the commodity price environment has improved significantly. The WTI crude oil price could end up averaging close to $50 a barrel in the fourth quarter. If the global oil production declines, particularly OPEC and non-OPEC members deliver on expectations by cutting their combined output by roughly 1.8 million barrels of oil per day from January, then oil could end up averaging north of $50 a barrel in 2017.
Secondly, Vermilion is also planning to increase its production to grow to the range of 69,000 to 70,000 barrels of oil equivalents per day in 2017. This depicts a 10.3% growth at the mid-point from this year's guidance. The growth will be largely driven by increase in output from Europe.
Improvement in commodity prices and increase in production will have a positive impact on Vermilion's earnings and cash flows. This should lay the foundation for future dividend growth.
Dividend investors should note, however, that Vermilion, like all other Canadian companies, pays its dividends in Canadian dollars. This leaves the dividend income exposed to strength in the value of the US currency or weakness in Loonie.
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Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.