Vermilion’s investor day highlighted its self-funded growth and income business model. Management’s commitment to providing shareholders a sustainable dividend is supported by a deep and diverse portfolio of assets resilient to a volatile commodity price environment. Project inventory supports a recycle ratio of over 2.5 times and the short-cycle nature of growth capex means spend can be rapidly diverted to projects that offer the highest returns or are curtailed. Our base case valuation falls to C$54.5/share (from C$57.9/share), largely driven by a global E&P sector de-rating. The share price is well supported by an 8.2% yield, which we believe is fully covered (in addition to growth capex) at c 20% below our base case commodity price forecasts for FY19.
Based on our analysis, we believe both dividend and growth capital are secure at commodity prices up to 20% below our base case forecasts (20% below our base case implies a price deck of WTI US$51.9/bbl and Brent US$57.5/bbl for FY19). If average oil prices remain below these levels, we would expect management to restrict capital spend to projects that generate the highest returns, while maintaining leverage below 2.5 times net debt to fund flows from operations (FFO).
The Canadian E&P sector has de-rated by over 30% since our initiation on Vermilion in March 2018, which we believe is driven by a recent correction in the crude price and the huge disconnect at which Canadian heavy crudes trade relative to global benchmarks. We note that across Vermilion’s oil portfolio the volume weighted discount to WTI is just US$2/bbl, given its exposure to Brent and light sweet blends in North America.
Our updated valuation falls from C$57.9/share to C$54.5/share (down 6%) and is based on a blended approach using FY19 P/CF, EV/EBIDAX and multiple of free cash flow (FCF) plus NAV 5Y plan. Although we make modest changes to our FY19 FFO, down 1% at C$1201m, a key reason for the decline in our valuation is lower multiple ranges justified by a global E&P sector de-rating.