No Respite for Vermilion Energy (TSX:VET) Investors

Vermilion Energy (TSX:VET)(NYSE:VET) announced the suspension of its dividends. The stock has already been in a free fall. What should one do now?

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There is absolutely no respite for Vermilion Energy (TSX:VET)(NYSE:VET) investors. The massive stock fall in the last couple of months has already dug a deep hole in investors’ pockets, and now the company has announced it will suspend its dividends.

The suspension came as cash retention became necessary for the company amid weak oil and gas prices. Vermilion clarified that the suspension will take effect after its scheduled dividend payment on April 15.

After two cuts, Vermilion Energy stops dividends

The $800 million Calgary-based Vermilion Energy already trimmed its dividends twice last month. However, the complete suspension of dividends until further notice highlights the dire situation for the energy company.

The crude oil supply glut is making things worse for the energy industry. To add to the woes, the pandemic-driven lockdowns are playing a double whammy. Despite potential production cut announcements by OPEC+ last week, the WTI crude oil price has been glued around $20 — levels not seen in the last three decades.

The production cuts were unable to uplift oil prices, mainly because the global demand is expected to fall by much more than that due to the travel restrictions and lockdowns. There is no way production cuts could match the level of demand declines at the moment.

Vermilion Energy management expects further deterioration in crude oil prices, which would make the picture bleak for other Canadian energy players as well.

Vermilion Energy plans to save approximately $550 million in reduced capital expenses, cut dividends, and other cost-cutting activities this year. However, crude oil prices at current levels for the longer-than-expected period could worsen the scenario.

Untenable dividends and frothy valuation

It would be impractical to discuss Vermilion Energy’s dividend yield now, but the super-high yield indicated that the company could not sustain it in the long term. In early March, after cutting its dividends for the first time this year, it was trading at a yield of 22%. This was significantly higher than its five-year average yield close to 6%.

Just look at the imbalance that Vermilion’s last year’s payout ratio highlighted. In 2019, it paid dividends of $2.76 per share, while its earnings per share were just $0.21. In late February, I’d stressed how Vermilion Energy stands on shaky grounds and its dividends look unsustainable.

Vermilion Energy stock is trading close to $5 at the time of writing. Even if it has surged from $2 levels in just a month, this should not be perceived as a lasting recovery. The stock has lost more than 75% in this COVID-19 market crash.

Importantly, the stock does not look attractive from the valuation standpoint, even after such a brutal selloff. It is trading 24 times its last 12-month earnings, which implies a premium against its historical average. Also, the uncertainty regarding this year’s earnings could keep investors at bay.

Things might get a little better in the energy markets in the second half of the year. The lockdowns will likely be released, and there will hopefully be demand surge for oil consumption. However, that cannot elevate oil prices substantially, because there will be millions of barrels of cheap oil in storage that need to be sold at bargain prices before starting new production.

Thus, the outlook for the energy sector in the short to medium term remains gloomy. How cash-starved energy companies like Vermilion Energy weather these challenging times remains to be seen.

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 Vineet Kulkarni has no position in any of the stocks mentioned.

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