A crude oil storage tank, left, and crude oil pipe operate at the Vermilion Energy pipeline and storage site in Vaudoy-en-Brie, near Paris, France, on Friday, Sept. 24, 2010. Companies are racing to drill for unconventional oil near Paris in a bet the area around the French capital is similar to sprawling Bakken Shale deposit in North America, estimated to hold billions of barrels of crude. Photographer: Antoine Antoniol/BloombergAntoine Antoniol/Bloomberg
Oil briefly crossed the $50 (U.S.) a barrel threshold last week. While it couldn't stand the rarefied atmosphere and pulled back, it shouldn't be long before it tests that level again. And when it does, you want to make sure you've got a few energy stocks in your portfolio.
We're still a long way from the $100-plus a barrel level that prevailed before the price war broke out in 2014. But the price is up about 85 per cent from the $27 mark it hit in January, which was the lowest since 2003.
The move over $50 set off a wave of speculation as to whether the rebound will continue, with some analysts expressing doubts and others predicting the price could go as high as $65 by year-end.
Most industry observers seem to agree that we have seen the bottom of the current cycle. Barring an unexpected global recession, the oil price is unlikely to slip back to below $40 a barrel. The longer-term trend will probably be higher. That suggests that you should gradually add a couple of energy stocks to your portfolio if you don't already own some.
One of my favourites in the exploration and production group is Vermilion Energy Inc. (VET-T; VET-N), which I recommended in June, 2014, at $75.79 (Canadian), and $64.68 (U.S.). That was when oil was trading at over $100 and almost no one saw the big drop looming. The price of the stock has dropped significantly since, but after falling to a low of $29.71 (Canadian) on the TSX in January, it's now trending higher. Here's what you need to know.
Background
Calgary-based Vermilion Energy is an exploration and production company with over 60 per cent weighting to oil and exposure to Brent-linked pricing. In 2015, it produced 54,922 barrels of oil equivalent per day (boe/d). Vermilion has internationally diversified assets with properties in Canada, France, Australia, Germany, and the Netherlands. The company is an efficient operator and has strong growth prospects in the medium-to-long-term.
Stock performance
From the fall of 2008 to spring 2014, the stock was in a steady upward trend. At one point it approached $80 a share in Toronto. However, the oil shock sent it into a deep decline, to a low near $30. It has looked better recently above $40, although it still trades below its 200-day moving average.
Financials
Like most oil producers, Vermilion is operating in the red. First-quarter results showed a loss of $85.8-million. However, that was a big improvement over the fourth quarter of 2015, when the company lost $142.1-million. Fund flows from operations were $93.7-million, down 31 per cent quarter-over-quarter and 22 per cent year-over-year. The quarter-over-quarter decrease was attributable to lower commodity prices and an inventory build in Australia.
The company has been aggressively cutting costs. It achieved savings of nearly $90-million in 2015 and is aiming to deliver up to $40-million in cost reductions this year. However, the key to returning to profitability obviously is a sustainably higher oil price.
Advantages
The company has several important advantages when compared to other Canadian exploration and production companies. For starters, it is internationally diversified, so a significant percentage of its production is exposed to world prices. Second, the company has done everything possible to protect its balance sheet, including retiring debt. In a message to shareholders earlier this month, management said that if there is a meaningful recovery in commodity prices this year the company will direct "the vast majority of incremental cash flow to debt reduction rather than increasing capital spending."
Third, Vermilion is one of the few oil and gas companies that has not reduced its dividend. It is still 21.5 cents per month ($2.58 a year), for a yield of 6 per cent. There is no guarantee that the company can continue to hold the line, of course, and it makes this clear in its financial reports. But after protecting the balance sheet, the directors have made retaining the dividend their No. 1 priority.
Outlook
The company projects average production of 62,500 to 63,500 boe/d in 2016. This is significantly higher than the 2015 average of just under 55,000 boe/d. The first-quarter figure was actually higher than guidance at 65,389 boe/d.
Capital spending this year is estimated at $235-million, a big pullback from last fall's guidance of $350-million.
Conclusion
Vermilion is in a good position to profit from a recovery in the oil market and its international exposure sets it apart from most other mid-size Canadian producers.
Action now
The stock is a buy for investors who are willing to assume above-average risk in return for higher return potential.
The author does not currently own shares in Vermilion Energy.
Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca.
Gordon Pape