Vermilion Energy investment thesis

Vermilion FY22 results – The year that could have been but wasn’t…

Introduction to Vermilion Energy FY22 results

Before analysing Vermilion FY22 results, for those unfamiliar with Vermilion. Vermillion Energy is an oil and natural gas producer with assets in North America, Australia and Europe. Currently, it produces around 81000 boepd. Although it expects to average 84000 in 2023 (51% Natural gas and 49% oil). Vermilion has exposition to American (WTI, Edmonton, HH) and European (Brent, TTF, NBP) references.

Vermilion Energy’s share price has crashed in the last months as a consequence of the steady fall in European gas prices and Windfall Taxes in Europe. Currently, it trades at US$13.6 / C$18.8, 55% lower than the peak reached last August.

Note: Henceforth, we talk about C$. Current exchange USDCAD = 1.3824

Vermilion Energy 4Q22 Results

4Q22 Vermilion’s results were heavily distorted by the recognition of the FY22 impact of European WFT in this last quarter. Taking out it, figures were similar to previous quarter

4Q22 FFO was $284 MM ($1.74/basic share), and if we exclude the impact of WFT for the full year, it was $507 MM ($3.11/basic share), which is similar to the prior quarter. The company generated FCF of $150 MM ($338 million, excluding the WFT impact).

The company’s production for the quarter was 85,450 BOE per day, which was impacted by unplanned downtime in Australia and third-party downtime in North America. Additionally, the delayed start-up of the company’s six-well Montney pad in Alberta also impacted production. Despite this, production in North America increased by 2% QoQ, mainly due to new production from the company’s Montney assets in Canada and a full-quarter contribution from the US drilling program. Montney production was around 7,500 BOEs a day in December. Additionally, Vermilion divested non-core assets in Saskatchewan, selling 5500 boepd of light oil for $225MM, which will be used to further reduce debt. 

On the other hand, production from international assets averaged 26,953 BOEs per day, which is down slightly QoQ primarily due to natural decline in Netherlands and Germany, as well as lower-than-anticipated production in Australia due to unplanned downtime. One oil well in Germany came online in 1Q23, and it drove one gross 0.5 net gas well in the Netherlands (in production in 2Q23). Furthermore, production from the Wandoo field in Australia was temporarily shut-in during December to repair a leak. However, it will remain offline for the entire first quarter as the company identified additional maintenance needs.

As a consequence of the disinvestment, it has reduced the guidance for 2023 which published in January, but we see this movement as positive as Vermilion had no plans to invest in them as Montney and BC offers a much better IRR

Overall, the 4Q22 results show that Vermilion Energy’s figures were heavily impacted by the European windfall taxes. Nevertheless, the company’s production increased in North America, and it has some upcoming projects that are expected to drive growth in the future

Vermilion FY22 Results

Vermilion achieved record FY22 results, FFO of $1.6 billion ($10.00/basic share) and net earnings of $1.3 billion ($8.03/basic share) including the impact of $406 million of realised hedging losses and $223 million of temporary European windfall taxes However, they have been quite diluted by the impact of hedges and WFTs. In fact, this is reflected in the behaviour of the stock, which has plummeted (in our opinion, excessively) since the rumours of WFT in early September (which coincided with the highest TTF prices).

Despite the impact of hedges and WFTs, Vermilion has managed to reduce its net debt by $300 million, exiting the year with net debt of $1.3 billion. The company has also made strategic acquisitions, such as Leucrotta Exploration in Montney and a 36.5% stake in Corrib, which is expected to close on 31st March.

Although the production in 2022 averaged 85,187 boe/d, similar to 2021 levels, it was a bit disappointing considering the expectations at the beginning of the year. However, the huge FFO allows Vermilion to launch an attractive return of capital framework, including not only a small dividend but also buybacks, which will increase as net debt diminishes by $1 billion, expected at the end of 2023.

Additionally, Vermilion has increased its proved plus probable reserves by 9% to 523 million BOE, primarily driven by the Leucrotta acquisition. And reduced its Open per barrel as a consequence of the sale of mature assets (Saskatchewan).

Outlook for 2023

Looking ahead to 2023, Vermilion Energy’s revenue may be impacted by lower commodity prices compared to 2022. Despite this, the company has made progress on its operations and development plans. In the first quarter, Vermilion drilled and completed a follow-up three-well Alberta pads, which will be brought into production in early Q2. Additionally, agreements with the Blueberry River First Nations and other Treaty 8 First Nations will help facilitate approval of future permits required to expand Montney development in British Columbia. With inventory in Alberta providing an operational buffer, Vermilion is now in a position to pivot back to the hard fall of inventory in BC, enabling the company to maintain production at capacity in Alberta for efficiency purposes. Looking ahead to 2024, Vermilion plans to drill 10 or 11 wells with a focus on building out its BC infrastructure, targeting production in the 12,000 to 13,000 BOE a day level.

Looking globally, Europe is expected to become even more dependent on LNG imports to meet its future demand, with the global LNG market already very tight. There is not expected to be any significant new supply entering the market until 2025 or 2026. So natural gas prices are expected to remain high during the next 3 years (although we do not believe that we see 2022 prices again). The company expects a reduction in operating costs of approximately $1 per BOE due to the planned asset sale and lower European gas prices (less effect of WFT). On an absolute basis, the temporary European windfall tax for 2023 is expected to be $200 million or less, compared to the $300 million guidance provided with the budget release in January.

As we discussed in previous Vermilion results analyses, the volume of Hedges has decreased considerably in 2023 and decreases practically to 0 in 2024. Additionally, with the current prices of AECO, Henry Hub, TTF, and NBP, they have no effect, or a positive effect in the case of Americans (but with low volume).

Guidance for 2023 82000-86000 boepd but 1Q23 production to be in the range of 80,000 to 82,000 boepd (sale of Saskatchewan assets and Corrib being acquired on 31 March). The Capex budgeted for 2023 remains at $570MM

They have already purchased 3.1 MM shares out of the 16MM program. Specifically, after resuming it in January 2023, Vermilion has acquired 0.48MM and 0.52MM shares in January and February respectively

Our Thoughts about Vermilion Energy’s current situation

In summary, Vermilion FY22 Vermilion results have been good, but there is a feeling of helplessness as they could have been much better. This is mainly due to the hedges made at the worst moments of the pandemic (when the company had much more debt) and the WFT. In addition, Vermilion has had the misfortune of being subject to retroactive WFTs in jurisdictions such as Ireland, where the applied rate is more typical of a communist system than a capitalist one.

Looking forward, we view the sale made in Saskatchewan favourably. These assets were not going to receive capital as Vermilion had better options (such as Montney or BC) where allocation was more beneficial. Additionally, this allows for a reduction in debt and brings them closer to their goal of $1bn of net debt, which they should easily achieve this year. As we have mentioned many times, the problem with natural gas in Europe is structural, and we believe natural gas prices will remain elevated until at least December 2025 (Qatar new liquefaction capacity coming online), as Europe does not have sufficient domestic production (completely disincentivized by governments) and has to pay more than Asia to import gas via LNG.

We believe that the next few years for Vermilion will be good as the commodity prices will remain high (despite the recession, as structural supply issues are greater – as long as a recession like the GFC does not occur and this one is milder). The proposed compensation scheme, as well as the gradual reduction of debt and expected cash flows in this price environment, make us optimistic about the evolution of Vermilion’s stock price

Disclaimer: We have exposure to Vermilion through equity and derivatives

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