Why I Am Bullish on Vermillion Energy Inc. Despite the Rout in Crude Prices

Vermillion Energy Inc. (TSX:VET)(NYSE:VET) appears undervalued after the rout in oil stocks, making it a solid long-term acquisition for the patient investor.

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Not surprisingly Canada’s energy companies have fallen into disfavour with investors because of the rout in oil prices. This now sees West Texas Intermediate or WTI trading at $46 per barrel and Brent at $48 per barrel, their lowest points in five-and-a-half years.

But despite these significantly softer crude prices a number of companies in the patch are still profitable and with the sharp sell-off of energy stocks, there are some attractive buying opportunities. One I believe that stands out is Vermillion Energy Inc. (TSX:VET)(NYSE:VET). Let me explain why.

Appears attractively priced

Since the rout in oil prices commenced around 6 months ago Vermillion’s share price has fallen by 37%, leaving it with some very attractive valuation metrics, including an enterprise-value or EV of seven times EBITDA.

Globally diversified portfolio of quality light oil assets

Vermilion has a global portfolio of light oil and natural gas liquid rich assets in Western Canada, the Netherlands, Germany, France and Australia that have oil reserves totalling 198 million barrels.

With a large amount of its oil reserves and production located outside of North America, Vermillion is able to obtain Brent pricing for a considerable portion of its oil production. This gives it an important advantage over many of its peers with assets solely located in Canada, because historically Brent has traded at a premium to WTI. At the time of writing, this premium has diminished considerably from being as high as 9% in mid-2014 to now be 3%, but it still gives Vermillion a pricing advantage over many of its Canadian peers.

More importantly the company has targeted production growth of 5% annually and despite slashing 2015 capital expenditures by 22%, it expects to beat that target this year, with production forecast to increase by 15% compared to 2014.

A strong balance sheet

Another of Vermillion’s key strengths is its solid balance sheet. At the end of the third quarter 2014, it had a high degree of liquidity with $142 million of cash on hand, along with a low degree of leverage with net debt of less than two times its operating cash flow.

This provides the company with considerable financial flexibility and leaves it well positioned to weather the current weakness in crude prices.

A juicy dividend yield

Unlike many of its peers Vermillion has not cut its dividend, leaving it with a tasty 5.5% dividend yield and a sustainable payout ratio of 71%.

More importantly in its 2015 guidance, the company flagged that it is committed to maintaining its dividend even if crude prices slip further, and it will do this by making further cuts to capital expenditures. This bodes well for the strength of its balance sheet and the sustainability of the dividend, making it hard for investors to resist that juicy 5.5% yield.

What does the future hold?

Investors need to be aware that this investment comes with risks, including considerable short-term downside if crude prices slide lower. But the long-term prospects appear solid, with the company looking far too cheap in comparison to the quality of its assets, steadily growing production and strong balance sheet. This means investors will need to be patient as they wait for oil prices to rebound, but while doing so they can continue to enjoy the sustainable and juicy dividend yield.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Matt Smith has no position in any stocks mentioned.

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