Published by Nick McCullum on June 14th, 2017
Oil prices fell off a cliff in 2014, and the shares of many energy companies followed closely.
While this might seem like a negative event on the surface, lower stock prices create higher dividend yields – and buying opportunities for opportunistic investors.
One energy company trading at an above-average dividend yield is Vermilion Energy (VET). The company’s 5.7% dividend yield makes it a member of the short list of stocks with 5%+ dividend yields.
Better yet, Vermilion Energy actually pays monthly dividends. Monthly dividends are ideal for some investors because they create a more stable income stream for those looking to generate portfolio income.
Vermilion Energy’s high dividend yield and monthly dividend payments make it stand out to dividend investors.
This article will analyze the investment prospects of Vermilion Energy in detail.
Vermilion Energy is an international oil and gas production company with a global operational footprint.
Founded in 1994, Vermilion Energy is headquartered in Calgary, Alberta, Canada and has a market capitalization of $4.1 billion.
More details about Vermilion Energy’s business model can be seen below.
Source: Vermilion Energy June 2017 Investor Presentation, slide 4
Since the company’s founding in 1994, Vermilion has experienced a truly exceptional rate of growth.
The company executed its initial public offering in April 1994 with an opening stock price of $0.30 per share. Currently, Vermilion is trading at a stock price of ~$33, which means that investors that have held since the IPO are holding a 100-bagger with a 5%+ dividend yield.
The company has reinvented itself a few times since its corporate inception.
In 2003, Vermilion Energy changed its corporate structure to that of a Canadian income trust, then converted back to a corporation in 2010. In 2013, Vermilion Energy was listed on the New York Stock Exchange, giving it exposure to a new group of United States-based investors.
Source: Vermilion Energy June 2017 Investor Presentation, slide 6
The company’s growth since its founding is nothing short of remarkable. With that said, Vermilion Energy still has a strong growth runway.
The company is driving growth through an attractive mix of organic expansion and mergers & acquisitions. Vermilion has a deep and diversified project backlog, allowing the company to pursue scale without sacrificing simplicity.
Further, the company’s decentralized business allows it to successfully operate in many disjoint geographies. Vermilion’s strategy can be seen in more detail below.
Source: Vermilion Energy June 2017 Investor Presentation, slide 7
The company’s recent performance has been quite strong.
Along with a 30.6% annual return since inception, Vermilion delivered 57.1% total returns in the past year after a few years of lagging performance. Despite the past year’s fantastic returns, Vermilion Energy has only delivered total returns of 1.0% per year for the past three years, largely thanks to declining oil prices in 2014.
The company’s total return performance is compared to various benchmarks in the table below. Dark gray cells indicate that Vermilion has outperformed the comparison benchmarks while light gray cells indicate that Vermilion has underperformed the comparison benchmarks.
Source: Vermilion Energy June 2017 Investor Presentation, slide 97
As mentioned, Vermilion Energy benefits from a considerable amount of geographic diversification.
Along with its core operations in the United States, Vermilion Energy has a meaningful presence in Europe and Australia, giving it exposure to three core operating geographies.
Source: Vermilion Energy June 2017 Investor Presentation, slide 39
The publicly-traded parent company acts as a holding company for three operating subsidiaries in Vermilion’s main geographies: Europe, North America, and Australia. At the headquarters level, staff focus on making capital allocation decisions while the operating business units are responsible for executing on their designated growth projects and delivering production, CAPEX, and OPEX targets.
The company’s corporate structure can be seen in more detail below.
Source: Vermilion Energy June 2017 Investor Presentation, slide 40
Moving on, the next section will discuss Vermilion Energy’s growth prospects in detail.
Vermilion Energy’s total returns have been extremely strong since the company’s inception in 1994.
This has been driven by underlying business performance. The company’s main yardstick by which it measures performance is fund flows from operations (FFO), a non-GAAP financial measure calculated by adding back non-cash charges like depreciation and amortization to net income.
2015 aside, Vermilion Energy has achieved double-digit percentage FFO growth in many of the past years. This is shown below.
Source: Vermilion Energy June 2017 Investor Presentation, slide 11
Along with strong profit growth (as measured by fund flows from operations), Vermilion’s business generates a substantial amount of cash flow.
The company has the highest free cash flow yield (which is calculated by dividing per-share free cash flow by stock price) of its peer group, and company-wide cash flow increased meaningfully in 2016 over the previous years. These trends can be seen below.
Source: Vermilion Energy June 2017 Investor Presentation, slide 13
Looking ahead, Vermilion’s exposure to multiple geographies and the company’s strong cash flow generation will drive its growth, as these factors combined allow Vermilion to be selectively opportunistic in the hunt for additional high-quality oil & gas assets.
Competitive Advantage & Recession Performance
Like many energy companies, Vermilion Energy’s competitive advantage comes from its asset base.
The company also benefits tremendously from its fantastic level of geographic diversification. This exposes Vermilion Energy to additional oil-rich regions while simultaneously isolating the company from any regional economic downturns or natural disasters.
Vermilion Energy was structured as an income trust at the time of the last recession, so its performance during that time is not comparable to the company’s performance today.
To assess the company’s recession resiliency, we can turn to its balance sheet structure.
First, it should be noted that Vermilion has a below-average level of leverage (when using the debt to cash flow metric) compared to both Canadian and U.S. peer groups.
This is displayed below.
Source: Vermilion Energy June 2017 Investor Presentation, slide 33
With that said, Vermilion’s leverage is above its historical average when measured using the net debt to FFO ratio.
As shown below, the company expects to deleverage over the next two years so that this ratio becomes closer to its normal historic levels.
Further, Vermilion Energy has ample credit capacity right now, with $1.8 billion of available credit capacity at the end of the most recent quarter.
Source: Vermilion Energy June 2017 Investor Presentation, slide 32
Altogether, Vermillion appears well-positioned to endure the next recession, although this company certainly doesn’t have the financial strength of many of the larger peers in the oil & gas industry.
Valuation & Expected Total Returns
Vermilion Energy’s future shareholder returns will be composed of valuation changes, growth in its underlying funds from operations, and the company’s current dividend yield.
As a company that owns and operates long-lived assets in the oil and gas industry, Vermilion Energy incurs substantial non-cash depreciation and amortization charges which artificially reduce the company’s earnings-per-share and make it difficult to analyze the company using traditional metrics such as the price-to-earnings ratio.
For example, Vermilion Energy recorded a $528 million depreciation charge in fiscal 2016.
One alternative valuation method is to compare the company’s current dividend yield to its historical dividend yield. If the current dividend yield is elevated, the company is undervalued; conversely, if the current dividend yield is lower than normal, the company is overvalued.
Vermilion Energy currently pays a monthly dividend of CAD$0.215 which is equivalent to annual dividend payments of CAD$2.58. The company’s current stock price of CAD$44.89 is trading at a dividend yield of 5.7%.
The following diagram compares the company’s current dividend yield to its long-term historical average.
Vermilion’s current dividend yield is 5.7% and its average dividend yield since 2010 is 4.9%. Based on dividend yield, this company appears to be meaningfully undervalued.
Interestingly, Vermilion Energy has traded at a lower dividend yield than its counterparts in the energy industry for the majority of its history as a publicly-traded company. Since the mini bear market in early 2016, this trend has reversed and Vermilion Energy has traded at a higher dividend yield than its peers (on average).
This trend can be seen below.
Source: Vermilion Energy June 2017 Investor Presentation, slide 16
The remainder of the company’s total returns will be generated from its profit growth.
As mentioned, non-cash depreciation and amortization charges impair this company’s earnings-per-share and result in Vermilion Energy reporting a net loss in many otherwise successful business years.
Thus, it is much more meaningful to analyze this company based on fund flows from operations, a non-GAAP metric that adds back
You can see an example of the reconciliation between net income and fund flows from operations in the table below.
Source: Vermilion Energy 2016 Financial Statements, page 15
In the decade preceding 2016, Vermilion Energy managed to compound its company-wide fund flows from operations at a rate of 4% per year. Since the company pays out so much of its cash flow as dividend payments, I believe that a long-term growth expectation in the low-to-mid single digits (3%-5%) is reasonable over full economic cycles.
To sum up, Vermilion Energy’s future shareholder returns will be composed of:
- 5.7% dividend yield
- 3%-5% growth in fund flows from operations
For expected total returns of 8.7%-10.7% before the effect of any valuation changes
Vermilion Energy looks to be an appealing investment from a number of angles:
- It has a dividend yield of 5.7%
- It has a strong total return history, delivering 30%+ total returns over a period of 23 years (although this will certainly not be repeated moving forward)
- It has shareholder-friendly management, shown in the company’s dividend policy
The company also pays monthly dividends, which combined with its high dividend yield make it a very attractive investment for income-oriented investors.
Thus, this stock is a buy for investors looking to generate regular and meaningful income from their investment portfolio. With that said, this stock does not have nearly the same amount of safety as large-cap energy supermajors like Exxon Mobil (XOM) or Chevron (CVX).