Is Vermillion Energy’s (TSX:VET) Dividend at Risk? 

The writer of this article may or may not have positions in the securities below. Current positions of the writer had no influence on the outcome of the research or stocks listed inside of this article.

Canada’s oil & gas industry has been decimated in recent months. Reminiscent of last year’s dip, the industry is mired in a significant downtrend. Over the past year, the TSX Oil & Gas Index is down 25%!  

Caught in the cross-hairs, Vermillion Energy (TSX:VET) is down 21% in 2019 and its value has almost been halved in the past year. At this time last year, the company was trading at $44.78 per share. Today it is touching 52-week lows around $23 per share. 

Now yielding 12.26%, is the company’s dividend sustainable?  

Second quarter results 

On Monday, the company released second quarter results. Unfortunately, they did little to appease investor’s concerns. Revenue jumped 8.4% year over year to $428.05 million, topping estimates by $79.15 million. Production of 103,003 boe/d jumped by 28% – inline with expectations.  

That was the good news. The bad news is that earnings of $0.01 per share missed by a whopping $0.23 per share!  

Likewise, funds from operations (FFO) per share of $1.42 also missed, coming in $0.10 lighter than expected. It also represented a 14% drop from the previous quarter. Lower FFO was mainly due to a refinery outage and lower natural gas prices. 

As of writing, the company’s payout ratio now stands at 122% and dividends account for 44% of FFO over the first six months of 2019. This is down from 48.9% through the first six months of 2019.  

Is the dividend safe? 

The company’s payout ratios don’t tell the whole story. Part of the Vermillion’s problem is that it has a high debt load. Currently it has a debt to cash flow of 2.2 times, at the higher end of industry averages.  

To improve its financial picture, it needs to repay some of that debt. However, after dividends and CAPEX, there is little free cash flow left over. At current strip pricing, estimates are for approximately $7 million in free cash flow, not enough to fund its current NCIB and to make a dent in its debt.  

As such, if the company wishes to deleverage it needs to make a few tough decisions. Reduce capital expenditures or reduce its dividend are two options that the company will seriously need to consider.  

This is not to say that a dividend cut is imminent, but paying out more than 100% of earnings is not a good business practice. Why? Because there is nothing left to dump back into the company to fund growth.  

Over the short term, it is manageable but it is not a sustainable long-term strategy.