EGY - Is Vaalco Energy A Good Dividend Stock?

2023-12-26 23:02:35 ET

Summary

• Vaalco Energy offers exposure to oil and gas dynamics in West and North Africa, as well as Cardium light oil and gas assets in Canada.
• The company's dividend narrative has picked up in recent years and we touch upon some of the internals that support the pickup.
• We close with some thoughts on the technicals.

Company Snapshot

Investors who are on the lookout for suitable micro-cap proxies to exploit oil and gas dynamics in West and North Africa may consider looking at VAALCO Energy ( EGY ). Note that in addition to its offshore assets in Gabon and Equatorial Guinea (currently undeveloped), and onshore assets in Egypt, EGY also offers some exposure to Cardium light oil and liquids-rich gas assets in Harmattan, Canada.

A Burgeoning Dividend Narrative

Besides the core oil and gas story, EGY has also started building up a very compelling dividend narrative of late. After years of dormancy, the company started doling out quarterly dividends of $0.0325 in 2022, and followed that up with a mammoth annual hike of 92%, for all its quarterly payouts in 2023.

Essentially, what you have is an ascending dividend yield trajectory which currently stands at an impressive figure of 5.36%. For context, the current “average” forward yield for other E&P stocks is only a little over 4% .

Don’t also dismiss the impact of these dividends on EGY’s overall performance over the past year. Note that on a price return basis, the differential between EGY and the SPDR oil and gas E&P ETF is hardly even 100bps, but when you factor in distributions and consider the total return for the whole year, the positive differential widens out to well over 400bps!

Gauging The Internals

Firstly, in order to support the dividend narrative, it's imperative for a company to maintain a solid balance sheet; in that regard, we’re happy to highlight that since 2018, VAALCO has not resorted to any bank debt, and the cash on its books has almost tripled ($103.4m) from what was seen last year ($37.4m). In addition to over $100m of unrestricted cash, EGY also has an undrawn RBL facility worth $50m.

Then, it's fair to say that EGY’s burgeoning dividend theme is founded on its merger with TransGlobe Energy Corporation which took place last year.

We’d like to think that the merger has de-risked EGY’s heightened exposure to the Gabon region which was subject to a military coup this year. Reports there suggest that oil and gas producers here could now be subject to greater scrutiny, and EGY’s operations in Egypt, and Canada could help mitigate some of the potential pressures on the anvil. Already this year, EGY has benefitted from some solid drilling momentum in those two regions, and we’ve seen the FY production targets for the company as a whole being lifted by 7% in Q3 relative to previous targets.

Note that the combined asset base has also started becoming more lucrative from an FCF perspective. Over a year ago, the asset base was generating negative FCF, but as the integration has progressed through the year, we’ve seen these assets yield mid-single digits of positive FCF.

Higher production has no doubt contributed here, but don’t also disregard positive developments on the cost front which look set to linger.

After bringing through around $3-5m of cash savings during the initial phase of the integration, management is now in the midst of improving back-office processes through the implementation of a single cloud-based ERP which could be instrumental in bringing through around $2-4m of cash savings.

Cash savings have also been generated by the installation of the FSO (floating storage and offloading) unit at the offshore unit in Gabon, which management had previously suggested could bring storage and offloading costs down by 50% . Now in Q4 , with the feed gas pipeline being resorted to the FSO, EGY could potentially benefit from lower diesel costs.

FCF also looks poised to get an uplift from better control on the CAPEX front. In Q3, cash CAPEX saw a sequential decline by -17% coming in at $22.5m , and management suggested that in Q4 this could come in even lower by -46% to -60% . Even next year at least in H1, CAPEX commitments will likely be largely centered around the Canadian operations and have been described as “pretty light”.

All in all, investors can be optimistic about EGY’s FCF coverage of its dividends ramping up in the coming quarters. For context, in Q3, the FCF already covered the quarterly dividend bill by a massive 10.7 x.

For the uninitiated, EGY doesn’t just resort to dividends but also deploys a fair chunk of its FCF via share repurchases, something which was only announced in Nov last year. As things stand the company still has around $10m yet to be deployed via buybacks before August (the $30m buyback program has a duration of 20 months) and likely impetus here should provide even further support for the share price.

Closing Thoughts- Technical Considerations

When it comes to the charts, we have a slightly mixed perspective but with a positive bias.

The relative strength charts help identify beaten-down stocks in any given sector that could potentially benefit from mean-reversion momentum. In VAALCO’s case we’ve juxtaposed it against other oil and gas explorers and producers, and what we can see is that, currently, its relative strength ratio is already trading quite close to the mid-point of its long-term range, thus limiting the incentive to rotate into the EGY stock.

Conversely, if we look at EGY’s own standalone price imprints over the last 50-odd months we can see that for most of this period, the stock had gained traction in the form of a pretty consistent ascending channel. It’s only largely in the first half of last year that we saw the price action getting overextended to the upside and breaking well past the upper boundary of the channel.

Now, in the second half of 2023, we’ve seen a pullback and a flattening out of the price action a little above the lower boundary of the channel. All in all, if one were to play the two boundaries of this channel, and pursue a long position at this juncture, we think the reward to risk looks fairly attractive.

For further details see: