In her Global Investing newsletter, Vivian Lewis occasionally works with a select group of contributing international specialists in various sectors; here, Martin Ferera highlights a new idea the Canadian energy sector.
Vermillion Energy (VET) was launched 25 years ago as an Alberta oil and gas company and listed on the Toronto exchange in 1996. Vermillion became less Canadian the next year when it bought into oil assets from Exxon near Lille, France.
In 2004 it bought into Dutch gas and the next year acquired an offshore gas platform on Australia's northwest shelf. It then proceeded to buy out the partners in these interests, got deeper into French oil, and acquired a natural gas project in Ireland.
More recently, VET expanded in Germany and Hungary and bought a private Saskatechewan operator. It even dipped a toe into the US. It focused on buying up under-appreciated assets wherever they were to be found.
I summarize the foreign ventures because they set VET apart from the Canadian oil competition which over the past 4 years suffered from low prices and a discount from benchmark West Texas Intermediate. Western Canadians cannot economically deliver oil to North American markets.
Vermillion meanwhile enjoys high gas prices being paid premium Brent rates not only in Europe but also topping the AECO index in Western Canada.
While almost every North American oil and gas company was forced to cut or eliminate dividends, VET increased the payout, most recently by 7% in C$s last month to 6.4%.
It also made its largest ever acquisition, of Saskatchean oil firm Spartan Energy in an all-share deal at about C$1.2 billion plus debt, a mere 5% premium over its traded price, under 5x cash flow. Spartan, one of Canada's most promising small producers, was acquired cheaply mainly because its managers needed to sell quickly as they held 10 million performance warrants which would run out at the end of this year.
Management had an incentive to sell. However there were no foreign buyers as they have fled the country for fear of battles over pipelines, increased regulation, and carbon taxes. And no Canadian had cheap enough capital to bid, except Vermillion. The Spartan deal increases VET's exposure to Canada to about 60%.
Before the deal, Vermillion had a C$5.6 billion market cap and debt of $1.5 billion. Spartan adds only a modest C$175 million of debt and boosts equity by $1.2 billion. This helps make VET a timely buy because an all-share offer will actually reduce Vermillion's debt to equity ratio. Net debt to funds from operations will drop from twice to 1.7x and the dividend payout ratio to 83%.
Moreover, Spartan has some of North America's most attractive assets, good market access, and some of the highest after-tax internal rate of return—despite being Canadian, according to the acquisition presentation. VET management owns about 6% of its shares, and looks after shareholders.
Scotiabank wrote about “the Vermillion Way”, starting with buying cheaply undervalued assets. Then “management applies capital efficient exploitation techniques, ultimately to materially outperform the decline curve” on those assets.
This gives VET “a competitive advantage” which with Spartan comes in the form of free cash flow and inventory in southeastern Saskatchewan, the “top quartile North Americas” oil market.
With oil prices rising and a drop in exploration and production, oil ready for the market is an asset play. Production is falling in Venezuela, Brazil, Angola, Mexico, and (if there are sanctions), Iran.
