VET:CC - Vermilion Earnings: Remember Europe's Energy Crisis? Neither Do I

2023-03-09 08:48:45 ET

Summary

• Vermilion's shares are down 50% from the highs of 2022. So what should investors think about now?
• Vermilion is priced at 8x after tax-free cash flow for 2023.
• And about 6x 2024 free cash flow, assuming no further windfall taxes.
• This gives no consideration to any potential buybacks that may take place.

Investment Thesis

Vermilion's ( VET ) Q4 earnings results show that bulls, myself included were wrong on this stock . We can try to squeeze the narrative around in order to make us feel less bad , but with the stock down 50% from its highs I believe the verdict speaks for itself.

So, what's next? It looks like this will now become a very long-term buy-and-hold stock for most investors that haven't yet thrown in the towel. The outlook ahead is ok and the stock certainly is on the cheap side.

But I no longer believe that the stock is so cheap that it will get investors pounding their chest to buy this stock.

In sum, for uber patient buy and hold investors this stock may eventually turn out OK. Hence, let's get to the post-mortem.

Europe's Natural Gas

Europe's natural gas prices have fallen more than 80% from the peaks. It's now clear, that the fear many had, myself included, that Europe would have problems keeping warm this past winter has turned out to be a false panic. But not just a wrong thesis. But embarrassingly wrong. So what's next?

The bulls will rapidly turn, point, pound, and shout, but what about next winter ?

Allow me to be frank and admit that I have absolutely no idea how next winter will play out. But I believe that next winter will also turn out to be just fine for Europe.

Moving on, Vermilion believes that looking ahead to 2023 as a whole, the average prices of TTF will continue to move lower.

Again, there's really no incoming spike in energy in Europe.

Vermilion Gets Investors to Think About 2024, After Windfall Taxes

The graphic above points to 2024. You'll see no consideration for windfall taxes. That's because Vermilion believes that starting in 2024 windfall taxes should not be in place.

Needless to say, that's a dangerous assumption. If for whatever case there were to be another spike in natural gas prices, we can be sure that governments will return to tax European fossil fuel companies.

That being said, I don't believe we'll see another natural gas spike this year or next. A spike or squeeze in a commodity comes from the unexpected taking place . It's a black swan event. The simple fact that I'm writing these words means that it's a possible event, which I'm considering, which by extension means it's not a black swan event, which means it's not likely to take place.

The figure above is cash flows before capex. Assuming CAD$570 million of capex this year, this means that Vermilion's free cash flow after windfall taxes will be around CAD$400 million, putting the stock at 8x 2023 free cash flow.

And then, assuming that natural gas prices remain stable in 2024, we could expect to see around CAD$500 to CAD$600 million of free cash flow next year. This figure could be slightly less, if we assume that after the Corrib acquisition, which closes on 31 March, capex requirement will need to increase.

Reserve Profile

There has been a lot of focus on Vermilion's reserves. So, Vermilion now shows that PDP or proven developed producing wells, make up more than 50% of its CAD$52 per share asset value. Given that its share price is less than half this figure, this implies that there's some margin of safety in its share price.

But again, I don't believe that's where the core thesis is to be found. The bull and bear case are on what natural gas prices could be in 2023-2024. If natural gas prices were to run, Vermilion has a lot of unhedged exposure to these higher natural gas prices.

But otherwise, Vermilion's valuation is very much in line with its peer group.

Note, Vermilion trades slightly cheaper than some of its peers because there have been questions over the depreciation rate of Vermilion's asset base.

But one way or another, Vermilion's valuation is OK, but not an outlier from the rest of the group.

The Bottom Line

In Vermilion's press statement, it says :

[Our] results translated into a total shareholder return in excess of 50% including share price appreciation and dividends.

I've tried to figure out this statement. Because from my conclusion, I only see that the share price is down 50% from the highs of last year.

That being said, looking ahead to 2024, assuming no further windfall taxes and no further meaningful declines in natural gas prices, no large increase in capex associated with the Corrib acquisition, and no significant ramp-up in buybacks, the stock trades for about 6x next year's free cash flows.

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