Should You Take a Bite Out of This 10% Yield?

Can Vermilion Energy Inc. (TSX:VET)(NYSE:VET) sustain its dividend now that it’s at a yield of 10.2%?

| More on:
Lady making handwritten notes next to a computer

Image source: Getty Images.

You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn more

Dividend yields add to total returns. High yields are mesmerizing, but most of the time when yields get to that level, investors start wondering if the dividends are sustainable.

Vermilion Energy (TSX:VET)(NYSE:VET) currently offers a yield of 10.2%. Can you trust the oil and gas producer to maintain its dividend?

Is Vermilion Energy’s +10% yield sustainable?

On Vermilion Energy’s (TSX:VET)(NYSE:VET) website, it says it pays a reliable and growing dividend. The company has been keeping its word; since 2003, it has maintained or increased its cash distribution or dividend.

Vermilion pays dividends from its cash flow, which is affected by changing commodity prices. At a high level, its production mix is about 35% WTI oil, 18% Brent oil, 20% Alberta gas, and 19% European gas.

This translates to WTI oil contributing to about 51% of funds from operations, Brent oil contributing about 28%, and European gas contributing about 20%.

You’ll notice that Alberta gas is out of the picture, because gas prices are ridiculously low there. I’m thankful for its commodity diversification; Vermilion’s free cash flow contribution is divided among WTI oil (43%), Brent oil (29%), and European gas (28%).

question mark

Historically, Vermilion’s payout ratio (accounting for dividends and both sustaining and growth capital expenditures) has been as low as 59% and as high as 162% since 2003.

Depending on how severe the commodity price drops will be and how long they stay down for, Vermilion’s dividend may or may not be sustainable.

If the WTI price were at US$60 per barrel or higher, Vermilion’s funds from operations this year will have no problem covering its dividend and capital spending. However, when the WTI price drops to US$50 per barrel, that starts cutting into its growth capital. Assuming no growth capex, Vermilion can sustain the dividend even at a WTI price of US$40 per barrel.

As of writing, the WTI oil price sits at US$52 and change per barrel, which barely covers all the spending the company needs.

Foolish takeaway

The fact that WTI is at about US$50 starts cutting into Vermilion’s growth capex. So, whether the 10.2% yield is sustainable or not depends on if management will decide to forgo growing production to protect the dividend.

From the company’s long history — 16 years — of keeping its dividend safe, management is likely to maintain the dividend with all its power. That said, it also depends on how low commodity prices will go and how long they will stay down for. If, for example, WTI stays at the US$30 level for an extended period of time, the company cannot possibility healthily maintain the dividend.

Vermilion Energy stock is trading at multi-year lows and is very attractive from a price-to-cash flow perspective, as it trades at a multiple of about 4.3, while its long-term multiple is about 8.6. Thomson Reuters’s mean 12-month target is $42.70 per share, which represents 58% near-term upside.

So, the high yield is not the only consideration. Outsized price appreciation is also in the cards, but investors need to have an above-average appetite for risk and be very patient.

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 ENERGY INC.

More on Dividend Stocks

analyze data
Dividend Stocks

2 Safe Dividend Stocks That Could Help You Fight Inflation

A dependable stream of passive income is one way to help offset rising inflation rates. Here are two top dividend…

Read more »

edit Person using calculator next to charts and graphs
Dividend Stocks

Stay Invested in a Recession: Increase Positions in 2 Value Stocks

The suggestion of market analysts is to increase positions in two value stocks if you want to stay invested amid…

Read more »

Hand arranging wood block stacking as step stair with arrow up.
Dividend Stocks

3 Dividend Stocks to Buy as Inflation Surges in Canada

If you're worried about how surging inflation may impact your portfolio, here are three of the best dividend stocks to…

Read more »

You Should Know This
Dividend Stocks

High Inflation: The Good and the Bad for Canadians

Consider tucking away some of your long-term savings in quality dividend stocks like Brookfield Infrastructure in this correction.

Read more »

STACKED COINS DEPICTING MONEY GROWTH
Dividend Stocks

TFSA Investors: Turn $1,000 Into $10,000 in 10 Years

10-fold growth within a decade is rare but not unheard of. You can capture this growth either by predicting a…

Read more »

edit Real Estate Investment Trust REIT on double exsposure business background.
Dividend Stocks

1 Oversold REIT Stock to Buy for Safe Dividends

If you're looking for stable dividend income from an oversold stock, this office REIT is a perfect option.

Read more »

edit Real Estate Investment Trust REIT on double exsposure business background.
Dividend Stocks

3 Cheap Canadian REITs to Buy in 2022

Are you looking for passive income? Start treasure digging in cheap Canadian REITs in this market correction!

Read more »

Dividend Stocks

TFSA Passive Income: 3 Undervalued, High-Yield TSX Dividend Stocks to Buy Now

These top TSX dividend stocks with high yields now look attractive to buy for TFSA passive income.

Read more »