This time last year, Vermilion Energy (TSX:VET) stock was the talk of the town due to its huge market-beating surge. The Canadian mid-cap energy producer is again in the news in 2023 but for being a consistent laggard.
Image source: Getty Images
What’s next for Vermilion Energy stock?
It doubled last year till August 2022 but has been on a constant decline since then. It has lost 25% so far, way underperforming TSX energy stocks’ 6% dip this year. Mainly the gas price correction in European markets and a windfall tax burden have weighed on it.
Vermilion Energy is a $2.6 billion energy upstream company that has operations in North America, Europe, and Australia. Almost 67% of its production comes from North America, while the rest is international. Its huge gas operations in Europe drove the financial growth last year, thanks to the gas price surge after the Russia-Ukraine war.
Vermilion produced 82.4 thousand barrels of oil equivalent per day in Q1 2023, marking a 4% drop year over year. The decline came due to an unexpected downtime in Australia. Free cash flows halved during the quarter due to lower production and windfall taxes.
Windfall taxes and Vermilion
Oil and gas prices shot up after the Russia-Ukraine war last year. Energy production companies were some of the biggest beneficiaries of this. Interestingly, they saw a significant earnings boost in the last few years, despite keeping production somewhat constant. This did not go well with regulators.
As a result, European authorities levied windfall taxes, called Solidarity Contribution, of at least 33% on energy producers. While Vermilion’s international reserve has been its key competitive edge over Canadian peers, the same has weighed on its growth in 2023.
Vermilion has attained its best financial position ever with rapid debt repayments. At the end of Q1 2023, it had net debt of $1.4 billion and a leverage ratio of 0.6 times. Almost all energy producers have seen balance sheet improvements as they focused on debt reductions. The industry-average leverage ratio was around 3 times before the pandemic, which has now improved to 0.5 times.
As many have already achieved their debt target, they distribute around 50% of their free cash flows to shareholder returns in 2023. In Vermilion’s case, it intends to distribute 25%–30% of its free cash flows via dividends and buybacks. Some of the bigwigs will move to distribute 100% of their excess cash to shareholder returns later this year.
Investor takeaway
So, Vermilion’s weakness has been evident to some extent. However, the same has made it some of the cheapest stocks in the sector. For example, it is trading 3.5 times its 2023 free cash flows, while the sector average is around 7 times. If the gas prices recover, we could see a massive surge in VET stock, driven by its depressed valuation and earnings growth potential.
