Written by Brian Paradza, CFA at The Motley Fool Canada
Oil prices are surging in September 2023, and energy producers are making good money as the West Texas Intermediate (WTI) oil benchmark hovers at US$89 per barrel. Canadian investors looking to make a value investment in the energy sector could make good money on Vermilion Energy (TSX:VET) stock over the next 12 months. The $3.5 billion oil stock’s history of capital losses could be over, and a new era of positive investor returns could be at hand. It may outperform top oil stocks in 2024.
Vermilion Energy stock’s 12.6% year-to-date decline may not correctly reflect the positive developments taking place at the light oil and natural gas producer this year. Rising oil prices, resilient gas prices in Europe, and higher productivity in Australia are positive developments that may combine to sustain a rally in VET stock into 2024. I’m bullish on this shunned value stock’s outlook for the next year.
Positive developments at Vermilion Energy in 2023
Vermilion Energy’s investor returns policy, current operating environment, and evolving balance sheet quality improvement make it a cheap value stock to buy now and hold in 2024.
The company used to be a heavily indebted oil and gas producer since 2015. Investors were right to shun the energy stock, and it has lost almost 60% in value from its June 2014 peak. However, that sad era is potentially over.
Vermilion’s debt per barrel of oil equivalent per day (boe/d) has decreased by over 40% since 2014. Net debt has declined from $4 billion in 2020 to about $1.3 billion as of the second quarter of 2023.
Interestingly, Vermilion’s net debt-to-funds from operations (FFO) multiple has significantly improved from 4.0 in 2020 to 1.0 going into the third quarter of 2023. The company can simply pay off its debt using one year’s operating cash flow today instead of toiling for four hard years to pay off its lenders.
Equity investors in VET stock have limited debt risks to worry about now. Vermilion Energy has successfully reduced its debt, and its leverage metrics could improve further in 2024 if good oil prices and European gas prices continue to richly bless its cash book. Management forecasts that Vermilion’s net debt-to-FFO multiple could touch 0.5 again by the end of next year. And that’s a key point.
Vermilion used to have a net debt-to-FFO multiple of 0.5 back in 2008 and in 2009 before the metric rose above 1.5 by 2014 — the year VET stock printed all-time highs. Leverage skyrocketed post 2014, and a debt drag going into weaker oil price cycles pulled down the energy stock’s valuation. That drag is going away, thanks to generous oil and gas markets.
Why buy Vermilion Energy stock in September 2023?
Vermilion Energy stock could reward investors, as the company carries through with a shareholder-friendly capital management policy.
The company’s business model currently emphasizes free cash flow generation and returning capital to investors when economically warranted, and firm energy prices are cooperating very well so far in 2023.
The energy company is actively repurchasing its shares. It targets returning 25-30% of free cash flow to its shareholders in 2023 through dividends and share repurchases. The allocation could increase to about 50% once Vermilion achieves its $1 billion net debt target. The target is well within reach by 2024 if oil prices hold above US$76 a barrel (WTI) while natural gas prices average above $3 at the AECO price and $24 in Europe.
Chances are high that Vermilion Energy stock could attract a better valuation, as it increases its rewards to loyal shareholders over the next 12 months.
Shares currently trade cheaply at 4.4 times the company’s projected free cash flow over the next 12 months. Vermilion stock trades significantly cheaper than most of its energy peers. Energy stocks can be much more expensive. For example, Canadian Natural Resources stock trades at 10.4 times next year’s free cash flow.
The post This TSX Energy Stock Could Be a Value Play to Consider Right Now appeared first on The Motley Fool Canada.
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