Should You Buy Vermilion Energy Inc. (TSX:VET) for a +6% Yield?

Vermilion Energy Inc. (TSX:VET)(NYSE:VET) successfully acquired Spartan Energy. Now what?

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In April, I wrote an article on Vermilion Energy Inc. (TSX:VET)(NYSE:VET) acquiring Spartan Energy. I’d noted that Vermilion was getting a good deal on the small-cap, oil-weighted, high-netback business, which had low-decline oil assets and strong free cash flow and future growth potential.

Vermilion was paying an enterprise-value-to-funds-from-operations multiple of 4.7 times for the acquisition, which was a sweet deal, as Spartan will be accretive to its funds from operations per share by 15% and production per share by 7%. Vermilion increased its production guidance to between 86,000 and 90,000 barrels of oil equivalent per day as a result.

At the time of the announcement, I held Spartan stock, which was converted to Vermilion stock officially yesterday in my account.

How Vermilion’s business looks like now

Vermilion estimates that on an annualized basis, it will generate 60% of its production from North America, 35% of its production from Europe, and 5% of its production from Australia.

In terms of funds from operations, it will generate 53% from North America, 40% from Europe, and 7% from Australia. In terms of free cash flow, it will generate 37% from North America, 53% from Europe, and 10% from Australia.

You might be wondering why Vermilion will get strong free cash flow compared to its production levels in Europe and Australia. A part of the reason is that Vermilion enjoys premium pricing from its production outside of North America. In particular, it enjoys higher European gas and Brent oil prices compared to Canadian natural gas and WTI oil prices.

Dividend

One of the big concrete differences of jumping from being a Spartan shareholder to being a Vermilion shareholder is that I now get a nice dividend. Oil and gas producers are more volatile than the average stock, so it helps a lot when you get a juicy dividend as a part of your total returns.

Vermilion currently offers a nice yield of almost 6.2%. And it’s reassuring that the company just increased its dividend a couple months ago. In fact, it has at least maintained its monthly distribution and actually increased the distribution four times for a total boost of 35% since 2003.

Price appreciation potential

You can get a nice dividend while you wait for price appreciation on the stock. The analyst consensus at Thomson Reuters Corp. has a 12-month mean target of $53.70 per share on the stock, which represents about 19% upside potential based on the recent quotation of about $45 per share.

Notably, some of the analyst estimates might not have been updated with the Spartan merger. The Bank of Nova Scotia analyst seems to have accounted for it and has a one-year target of $60 per share on Vermilion, which implies about 33% upside potential.

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 Kay Ng owns shares of Vermilion and Bank of Nova Scotia.

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