Vermilion Energy investment thesis

Vermilion Energy $VET – Investment thesis

Vermilion Energy Investment Thesis $VET

Vermillion Energy is an oil and natural gas producer with assets in North America, Australia and Europe. Currently, it produces 84500 boepd (47% natural gas, 37% Light & Medium oil and 15% NGL condensates). Both oil and natural gas production has exposition to American (WTI, Edmonton, HH) and European (Brent, TTF, NBP) references.

After diminishing its Capex and consequently its production because of Covid-19, Vermilion plans to reach a production of 100’000 boepd in 2023. Both organically and inorganically ( It has recently acquired assets in Canada and expanded its exposition to Ireland). High oil and gas prices (mainly in Europe where it has 38% of its natural gas production (exposed to TTF and NBP) are flooding Vermilion with money. Furthermore, Vermilion was heavily impacted (C$145MM) in the 1Q22 as a consequence of hedges, as it was in the 2Q22 (C$80MM). However, this situation is changing as the bad hedges are finishing, and $VET is starting to roll them into new hedges with much better prices.

Vermilion pursues an aggressive return of capital framework focused on repaying debt and increasing the amount of FCF to shareholders. Currently is buying back 10% of its market cap, but if energy prices continue high for a while (we believe it will happen), $VET will increase the size of the buybacks, increase dividends and potentially make a substantial tender offer.

As we have explained several times over the last 18 months,  we believe that there is an important dislocation between the supply and demand of energy in the world as a consequence of the lack of investment in the last years (even before Covid). Now, companies are not filling the gap due to fears of ESG, regulations or the phantom of 2014-2015 crack in prices. This situation is even scarier in Europe, where Vermilion has a considerable exposition and is exploring options to continue growing.

We believe that $VET is well managed, diversified, in a good financial position, and its stock is relatively cheap regarding the free cash flows that is expected to obtain in the following years (being quite conservative with the energy prices in our calculations). 

Vermilion production MORAM

Date: 18th Sept 2022

Capital Structure*

1Common Shares$3811MM
2Preferred Shares0
3Net Debt$1225MM

Main Shareholders

$VET shareholders Moram

Earning Metrics

C$MM202020212H22
Revenue111920791669
FFO502919.8842.7
EPS-9.617.133.96

 Stock Information

165MM**nº shares
2.8MM3mth avg vol
1.6Beta
$7.11-30.17         52 Week Range

*All the analysis is referring to $VET (United States, not $VET.TO Canada). Also, in the valuation section, all figures are in US$ if the contrary is not specified

** Buyback program in place (16.07MM shares targeting)

Vermilion energy share price $VET

What assets owns Vermilion Energy?

Canada
Canada is the most important jurisdiction for Vermilion. It represents more than half of its production. Vermilion’s Canadian operations are primarily focused on the West Pembina region of West Central Alberta (Montney area – Tier 1 inventory for more than 20 years) and southeast Saskatchewan and Manitoba. In West Pembina. West Pembina is the Company’s main natural gas liquids (“NGL”) producing area. The primary asset in Montney is Mica, where they have recently acquired the Leucrotta assets and there is an infrastructure plan in place to achieve a production of 28000 boepd. It would represent an annual FCF >US$160MM at strip prices.

Vermilion has 644.0 (401.0 net) producing conventional natural gas wells and 3,392.0 (2,132.0 net) producing light and medium crude oil wells. They plan to drill 14.7 net wells in Alberta, 9 additional wells in Montney, 28.8 in Saskatchewan and 6.2 in the US (Wyoming)

Canada assets means 52% of the Light and Medium cruide oil production and 59% of the natural gas production. However, because of the high prices in Europe, it represent a much smaller amount of the total sales. The production grew until 2020 when they stopped the investment in order to manage liquidity (Covid). Currently, they are focused in M&A in Europe and increase the diversification (internationally) but Canada is its main area an the core of the company.

United States
$VET entered the US in 2014. It owns assets in the Powder River basin and Hilight field(NE Wyoming). Vermilion has 195 (167.6 net) producing light and medium crude well oils. In 2021 drilled four net wells on its Hilights assets and is drilling 6.2 net wells in 2022. Around 55% of its production is oil, 25% NGL and the rest natural gas (linked to HH). Their fields are tied to high royalties. However, the transportation and operating costs are low.

Netherlands
Vermilion entered the Netherlands in 2004 and is the country’s second largest onshore operator. All its production in the country is natural gas. It operates its onshore concessions 28 and also has 19 non-operated offshore concessions. $VET reached peak production in the Netherlands in 2019, but it has been declining since then. In 2022, they expect to drill in the 2H22 two gross (1.1 net) natural gas wells. Vermilion’s operating costs in the Netherlands are higher than in other jurisdictions, but there are no royalties. We will be monitoring the decision about taxes that the EU has to take in the next two weeks as well as the Dutch annual budget that will be presented on the 20th of September to know the decision on new taxes. At this moment, Dutch assets linked to TTF are the goose that laid the golden eggs. Consequently, the taxes decision along with the Capex invested in the country are of capital importance.

Germany
$VET entered the country in 2014, and they have been growing its assets since then. It produces 75% natural gas and 25% oil. Vermilion has 66 (56.5 net) production oil wells and 20 (11.4 net) wells producing natural gas. Thanks to the acquisition, its production of natural gas has grown considerably in the last five years as also increased slightly its oil production. Moreover, they are drilling a three-well program in 2022. Recently Germany has increased its royalties, but they are still lower than in France (transportation and operating costs are also lower than in France)

Ireland
Vermillon has a 56.5% interest in the Corrib field (20% + 36.5% acquired recently and expected to close 4Q22). It is an offshore field that means 100% of the Irish natural gas production. Its gas is referenced to the NBP price. Currently, it has one net well producing. The maintenance investment has been limited during the last years, and it has around a 15% natural decline. Production in Corrib is not subject to royalties. In the 1H22 it produced 4800 boe/d. 

France
Vermilion is the largest oil producer in the country with approximately two-thirds of the domestic market share. It operates in two basins, Aquitaine Basin and Paris Basin (conventional fields with large OOIP, high working interests and low base decline rate). The oil produced is referenced to Brent. Royalties in France are high and include charges based on a percentage of sales and fixed per Boe charges. They have not done any acquisitions in the last five years. Investing around $40MM yearly, they can maintain the production with a minimum decline of around 8700boep. This year, that number will be in the low of 8000 due to a fire in one of its assets. France represents the international area where $VET has been investing the most in recent years. It has an extensive inventory of workers and infill drilling opportunities ahead to increase production.

Australia
Vermilion owns the Wandoo offshore crude oil field, located on Western Australia’s northwest shelf (close to where Jadestone has its Australian assets). The field is located in block WA-14-L, with a water depth of 184 feet. There are 19 producing wells tied to platforms Wandoo A & B. Production has been declining in the last years, and it expects to continue in the future as Vermilion is drilling 2.0 net wells in the 2Q-3Q22, but it does not expect to drill any additional Australian wells for another two to three years thereafter.
There are no royalties in Australia, but it has a specific tax (PRRT) that works similarly. The operational costs are high as it is an offshore location. They receive a premium to Brent as the reference in this area of Australia is Tapis. (same as Montara – Jadestone)

Central & Eastern Europe
Vermilion has a unit in charge of developing opportunities in the lands it owns in Hungary, Slovakia and Croatia. $VET drilled in 2021 one net well in Croatia and another in Hungary. It plans to continue its drilling program in 2022 with two natural gas wells in Croatia two crude oil and one shallow gas well in Hungary. We expect $VET to continue developing its assets in these three countries in the next years.

MORAM $VET reserves

 

How is the Management & Debt of Vermilion?

Recently, Lorenzo Donadeo the founder and chairman retired. Nevertheless, the management line of decisions is not going to be compromised. Vermilion has in place a return of capital framework focused on increasing shareholder returns. Under the current macroeconomic situation, we expect Vermilion to proceed with share buybacks, dividend increments (less than the other options) and tender offers during the next few years.

$VET Return of capital allocation program Moram

Vermilion currently has C$300MM Senior unsecured notes (2025) at a 5.63% interest. It has a redemption option in 2023 at 101.4% of par and descending after that year. $VET also have C$400MM unsecured notes (2030) at 6.88% interest with reception options starting in 2025 (103.44%) and descending until 2028 when it would be able to cancel its debt at par. There is also a revolving with a C$1.6bn limit where C$639 have been retired – Maturity May 2026 and interest around 2% plus LIBOR.

 

Valuation $VET share price

We have valued each country of Vermilion separately. Each of them is exposed to a different benchmark (WTI, Edmonton, C5, Henry Hub, Brent, TTF, NBP), and have different cost of production, royalties, transportation and taxes. Regarding the hedges, we also differentiated by benchmark and then we did our best assumption as $VET group them into the corporate segment (normal procedure). By following this method, we have been able to estimate the income taxes by country (as each of them has a different % tax, tax pools, Capex rules,…). Samely, we estimate different decline rates by country based on the production history, Capex and management’s comments about the assets.

  • We use the current forward curve for each benchmark, but we used more conservative numbers in our model.
  • The model does not include any potential acquisition after Leucrotta and Corrib.
  • Capex’s assumption is C$550 for 2023 and 2024, $400 plus inflation 2025 and beyong.
  • The debt repayment schedule is the one presented in the 2Q22 presentation in August 2022
  • Hedges are considered as of 31st August
  • Assumptions to WACC calculation are: Risk free = 3.4%, Risk Premium = 6.45%, Beta = 1.6.
  • Income taxes are applied as of today, we will update them as soon as the EU publish the ones for next year. (Canada 24.6%, US 21%, France 27.4%, Netherlands 50%, Germany 31.4%, Ireland 25%, Australia 30%)
  • USD / CAD = 1.33 (long-term exchange rate in our model has been set as 1.25)
  • The estimation for royalties, operating expenses, transportation cost, declines, Capex expenditure… are included in the model

Our estimated value for Vermilion is US$32.73

 

MORAM $VET Analysis

We always do a very elaborate model for each analysis. The main utility of models is to understand the sensitivity that has the company to specific events/factors and to take quick decisions based on what can happen next.

Risks

Commodity prices: Oil and gas prices are cyclical. Although Vermilion is quite prudent with hedges and if prices fall they will be benefited from the ones they are signing now. Also, we believe that prices are going to be high for a while. For example, this week the US published that they expect to refill its SPR at prices around $80, so that is kind of floor… but again, very volatile markets and anything can happen.

The EU regulation: Vermilion has been beneficiating from elevated TTF and NBP prices. They have a presence in several European countries but it looks like their profits are going to be reduced (Netherlands, Ireland, Germany and France are mostly impacted). We will update you on this topic as soon as we have something definitive.

Operational Unexpected problems in the fields can hit production. This year has been a fire in France and problems in Australia. It is prudent to assume that a small percentage of the production will be hit every year.

Is Vermilion Energy a good buy? Our thoughts about $VET

After this analysis of Vermilion Energy, we believe that Vermilion is in a much better position than its peers in the industry thanks to its diversification and exposition to European natural gas. They are doing their homework (reducing debt), and at the same time, they have continued acquiring assets at fantastic prices. The additional 36.5% in the Corrib natural gas field in Ireland is a perfect example as because of its economic interest starting 1st January 2022, the asset is going to be almost paid by the time that they officially take control of the asset (it will be a remaining C$100-130MM if they close in the 4Q22 as expected).

We also believe that energy problems around the world are here to stay for some years, consequently, we believe that Vermilion is in an interesting position to take advantage of it. 

At the time we write, we have exposition through derivatives but we are also plan to add equity in the next weeks.

 

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