Canadian oil and gas stocks have had a positive start in 2023, while Vermilion Energy (TSX: VET) stock has been consistently weak. It has lost 50% of its market value since August 2022, notably lagging peers. Despite being one of the most undervalued stocks with enviable profitability, VET stock has seen an epic descent.
Why has VET stock halved in the last six months?
Vermilion Energy stock was among the top gainers last year. Due to the war in Europe, natural gas prices zoomed and notably boosted its earnings last year. However, the same European exposure led to its fall in 2023.
Vermilion is a $3 billion Canada-based oil and gas producer with assets in North America, Europe, and Australia. While one-third of its total production comes from outside North America, those assets contribute more than half of its total free cash flows.
While the world has grappled with high inflation, contributed mainly by higher oil and gas prices, energy companies are sitting on record profits. This has not gone well with the regulators.
As a result, they have announced windfall taxes on these profits. According to Vermilion Energy’s guidance, windfall taxes in Europe are expected to cost it around $250 million and $300 million for 2022 and 2023, respectively.
However, despite the big impact, Vermilion will likely see handsome free cash flows this year. Management expects free cash flows of around $3.1 billion between 2022 and 2024. So, near-term uncertainties like surplus taxes might continue to weigh on VET stock.
Vermilion Energy and free cash flow growth
Vermilion paused its share buyback plan when windfall taxes were first introduced last year. It resumed the buyback plan in January 2023. While peers have been aggressively buying back their shares recently, VET has been quite slow.
VET stock is currently trading at a 2024 free cash flow yield of 32%, net of the windfall taxes. This is substantially more attractive than the industry average close to 15%. Moreover, even if its free cash flows halve from the current levels, that’s still discounted against peers.
Apart from financial growth, its balance sheet will continue to improve with debt repayments. At the end of Q3 2022, VET had $1.4 billion in net debt compared to $1.7 billion at the end of 2021. While the absolute debt amount might still seem higher, Vermilion achieved its lowest leverage levels in the last 10 years.
For 2023, Vermilion aims to allocate 75% of its free cash flows to debt repayments and the rest to shareholder returns. As a part of this plan, it raised shareholder dividends by 25% to $0.1 per share. The dividend yield is still among the lowest at 2%.
The foolish takeaway
We will get more clarity on the impact of surplus taxes when Vermilion Energy reports its Q4 2022 earnings next month. Its discounted valuation is highly appealing at the moment. The stock could see recovery later this year as oil and gas prices turn higher and guidance materializes.
