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Canadian oil driller Vermilion Energy (NYSE: VET) offers investors a yield of more than 9% with a monthly payment schedule. That's enough to get the ears of most dividend investors to perk up. Now add that the energy company is globally diversified and growing its production, and Vermilion starts to sound like a pretty enticing investment. And in some ways it is, but you need to go in with your eyes open to the risks. Here's what you need to know before you buy Vermilion.
The good stuff first
Vermilion's business is broken down into three main parts: North America (62% of production and 52% of funds from operations), Europe (33% and 39%), and Australia (5% and 9%). It specifically focuses on more conventional oil plays with longer reserve lives and slower decline rates, which is very different from the fast-growing unconventional onshore U.S. energy sector, where shorter lives and quicker decline rates are the norm.
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The company is projecting 19% production growth in 2019 based on capital spending plans of roughly $530 million. Looked at on a per share basis, which takes into account the issuance of stock to fund the business, production growth in 2019 is projected to be roughly 8%. That growth has been helped along by two acquisitions in 2018, one in Canada and another in the United States, and continues the growth trend that's been in place since 2013.
In the first quarter of 2019 FFO per share increased 27% year over year, largely driven by increased production. Sequentially from the fourth quarter of 2018, FFO per share grew by 14%, helped along by a mixture of increased production and higher oil prices. And, after a long stretch of stable dividends following the deep oil decline in mid-2014, Vermilion upped its dividend again in 2018. So far, so good.
Some less desirable news
There's no question that oil companies are a little out of favor today, so it isn't surprising that Vermilion has a high yield. However, the 9%-plus yield is at the high end of the spectrum. And there are some pretty good reasons for this. For starters, the dividend cost nearly $100 million in the first quarter, which was roughly half of the $200 million in cash flow provided by operating activities. That's great until you add in the $230 million in capital expenditures the company made in the first quarter. To put it simply, cash flows didn't cover the dividend and capital spending in the first quarter.
That's just one quarter, and based on the full-year capital spending projection of $530 million, the rest of the year should see lower spending. If you use the first quarter as a run rate, the company will generate around $800 million in cash flow and pay about $400 million in dividends, leaving just $400 million for capital spending plans of $530 million. There are any number of ways that the shortfall here can be covered: Tapping the capital markets with debt and equity sales, using revolving credit lines, or an oil price increase (which is impossible to predict) could save the day.