Vermilion Energy Inc. (VET) Earnings Call Transcript & Summary

Good morning again. It's Arun Jayaram from JPMorgan's E&P team. I'm pleased to welcome Vermilion Energy as a presenter again this year. Also to welcome Curtis Hicks, who recently rejoined Vermilion as President. As many of you are aware, Curtis spent 15 years at the company, from 2003 to 2018, where he's CFO of the company and a strong contributor to the company's historical success. As a reminder, Vermilion is a diversified upstream company with key positions in North America, Europe as well as Australia. With that, I'll turn it over to Curtis to begin today's presentation. Curtis?

Thanks, Arun, and thanks to JPMorgan for hosting the conference today. We're pleased to be here and happy to give you some detailed information with respect to Vermilion. Just give me a second here while we get the slide show going. There you go. So as Arun said, we got -- we're an international oil and gas producer. We've got operations in 3 regions in the world: Europe, North America and Australia. We believe that a diversified asset base provides us with flexibility. We can direct our capital investment to the most profitable operations across the portfolio, and we have some commodity price risk built into the portfolio as a result of being exposed to different commodities and different pricing regimes. In addition, we are an industry leader, at least in our sector, in sustainability and ESG performance, and we think that's a critical factor going forward. On Slide 3, we show you the map of where our assets are located. And beside that, in the pie charts, the production and funds from operation, or FFO, contribution from each of the regions. On Slide 4, we talk about our ESG leadership. On the environmental side, we reduce the environmental impacts of traditional energy production through some renewable energy projects that we have on the go. And we started with the first project going online in 2012, so we've been doing it for 8 years now. We've got 2 projects online and a third project under construction, and we'll continue to look for opportunities where we can reduce the environmental impact of oil and gas production. On the social side of things, we are absolutely committed to the care of our people and to the enrichment of the communities where we live and work. On the governance side, much like environmental, for a number of years now, we've been recognized for our excellence in governance by a number of independent assessment vehicles, and we will continue to operate with the highest standards of ethics and integrity in our business. Slide 5 gives you just a quick snapshot of some of the key components of Vermilion. I would point out maybe of interest is at the bottom of the page, our 2020 guidance, production of 94,000 to 98,000 BOE a day this year and a capital spend in the order of $350 million to $370 million. So as Arun said, I just recently joined the company. We've had some senior management changes happened about 3 weeks ago. And our CEO left at that time, Lorenzo Donadeo, who is the co-founder of Vermillion, and President and CEO for a number of years, came back as Executive Chairman. I was appointed as President, and we reestablished an executive committee to really make key strategic decisions for the company. It's a structure that was in place when Lorenzo was a CEO, and we felt it underpinned the success that we had over a number of years as we made strategic decisions for the company collaboratively as opposed to individually. And so what happened to result in this management change? Well, back in 2003, we developed a series of core business principles, which are outlined on Slide 7. Over the last couple of years, Vermilion drifted away from these core business principles. Our debt levels drifted beyond sort of the targeted ratio that we wanted to maintain. And perhaps we were overly committed to a dividend strategy in a low and volatile commodity price environment that contributed to that. So we've made some changes to the company. The focus for us is to get back to adherence to these core business principles as we go forward. The near-term priorities for us, well, in addition to the management changes that were made, we addressed some of our cash outflows in the company. We suspended the dividend, so we eliminated $420 million of annual cash spend. We reduced our capital program by $100 million. And we looked at other areas of cost where we can -- or we have a little bit more control, and our staff have been able to reduce operating and G&A expenses by an excess of $35 million on an annual basis. So we've identified over $550 million of cash outflows that we can eliminate to date. So in the near term, we're going to continue to navigate through this pandemic environment. And I will say as with an independent perspective, as I didn't join the company until May 25, which it's obviously well into the pandemic environment situation, Vermilion has done an outstanding job in dealing with it and managing it across the portfolio. Our first priority is to pay down debt. We targeted debt to cash flow ratio of less than 1.5x. And we know it's going to take some hard work and it's going to take some commodity price recovery to get us there, but that is our primary focus here over the next couple of years. We'll continue to work to find additional operational efficiencies and cost reductions throughout our business. And we'll also continue to strengthen our leadership role in ESG. We think that's an important component of our business. And ultimately, we would like to get back to a business model that returns cash to our shareholders, and that will be through a combination of dividends and/or share buybacks. And the decision when to do that and in what form to do that will be made as we get in a better position to make that call. So in response to COVID-19, as I mentioned, I think Vermilion has done an outstanding job in doing that. We've had very moderate impact to our operations as a result of COVID. We outlined the details in our Q1 release. We had sub production in the Paris Basin in France we shut-in as a result of a refinery being shut-in. That refinery is now back on stream, and we're bringing our production in that area back up to full capacity here over the next few weeks. And beyond that, there's been an immaterial impact on our operations as a result of the COVID-19 environment. So here, we show you our historical FFO on the left-hand side of Slide 10. As you can see, we came out of the financial crisis in 2008, and we're able to respond and rebound price crash -- oil crash in 2000 -- in late '14 and into '15 and '16. Again, we responded and we're able to recover. So we firmly believe that we will be able to do the same thing as we respond to the price crash here earlier this year, and we'll be able to demonstrate strong recovery as we go forward. On the right-hand side of the screen, we show you our FFO and free cash flow, or FCF, on 2 different price models. Both of those incorporate actual pricing for the first part of the year and then assume either $40 or $50 for the balance. And even under a $40 price environment, we can generate some significant free cash flow that will be used to pay down debt. Free cash flow yield on Slide 11 is an assessment that was put out by RBC Capital Markets. And you can see Vermilion shows very well on this metric against its peers. So getting into the international arena. Slide 13 shows you our commodity diversification. On the left-hand side, we show you our production. And you can see that our liquids production of both Brent and WTI represent about 55% of total corporate production. And looking at the estimated FFO contribution for this year, that same product slate of liquids contributes about 77% of our FFO. So overweighted to the liquids side, which is a reflection of the value of producing oil and condensate globally, frankly. The European gas side shows 19% both in terms of production and estimated FFO contribution. It's a little bit unusual for us. Historically, European gas has contributed a much stronger component of FFO because of the premium that we received for our European gas. And you can see on Slide 14 on the right-hand side, where we graph European gas prices, both NBP and TTF in the Netherlands against some North American benchmarks. Historically, there's a significant premium for European gas. That premium compressed in 2019 and 2020 due to a combination of factors. Firstly, some warm winters the last couple of years, reduced the demand for this gas. And then the demand destruction resulting from the COVID environment further exacerbated that. As we go forward, we're confident that we will see the premium climb back into the market. And starting in '21 and moving into '22, the futures curve reflects a growing premium for our European gas. On the oil side, you can see it on the left-hand side, our oil and liquids. We show our various commodities that we sell globally benchmarked relative to TI. And at the end of the day, the total crude slate that we've got is sold at just a slight discount of $1 to WTI. So this represents a very attractive suite of oil and liquids. Hedge book, we show you on Slide 15. For 2020, we're corporately hedged at about 50% of production, about 25% for 2021. We will continue to look for opportunities to layer in more hedges, likely more in '21 than you'll see in '20, just given we need some strengthening in commodity prices before we feel comfortable in locking in or putting in various structures in place. But we'll continue to work the hedge book as we go forward. And just speaking to the balance sheet for a minute. As at the end of March, we had about $500 million in available liquidity on our credit facility. It's a facility that's just been renewed, turned out till March of -- or May of 2024. So we have no near-term debt maturities. And as we are -- as I mentioned, we're going to run the business on a more conservative basis and maintain a total payout ratio of 100% or less as we go forward. So we've got plenty of liquidity to execute our game plan. In Slide 18, we just show you a picture of our leverage ratio over time. And as I said, we've kind of gotten above our targeted ratios here over the last few years. You can see historically, from 2003 through '14, we were within sort of the range that we want to operate the business at. We've let it creep up, and we've got it to a point where we need to address the balance sheet and pay down some debt, one of the key priorities here over the next year or 2. But just to touch on some of our assets here briefly. Starting in Europe, we've got 5 core regions in Europe: France, Ireland, Netherlands and Germany are kind of steady-state production areas with some -- what we would call bread-and-butter opportunities to either drill and/or recomplete wells. Central and Eastern Europe, or CEE, is relatively new to the portfolio and has perhaps more significant upside. We've been building a land position here over the last 3 or 4 years. We've drilled a couple of exciting wells in Croatia, a couple of gas wells. One tested 15 million a day, a second test at 17 million a day, both on limited drawdowns. And we have another -- we have a number of interesting opportunities offsetting those locations. We expect to have those wells on production in 2021. A second really interesting prospect that shows in our CEE is in Hungary. We have a license adjacent to a competitor's license, where the competitor has developed an oil pool from a standing start in 2017 to approximately 12,000 barrels a day today. That pool seems to trend onto our acreage, and we have a number of interesting prospects to test here over the coming quarters and years. So we're excited about that. Our European production over time, you can see it starts in 1988. That reflects our entry into France. And you can see we layer in additional expansion over time to our existing production slate. In North America, we're focused in Alberta and Saskatchewan in Canada and Wyoming in the U.S. And all 3 of these jurisdictions have got some significant expansion opportunities for us here over time. And again, historical production in Canada and the U.S. You can see we got into the U.S. in '14, and the last couple of years have seen some good growth in production through an acquisition in '18 and some drilling activity in '19 and '20. And we expect that to continue as we move forward. And the last asset to touch on is Australia. We own 100% of the Wandoo field, which is offshore of the northwest shelf in Australia. It's an oil-producing field that has some unique characteristics to it. As a result, we sell it into a niche refinery market in Asia, and this crude commands a premium for Brent. Typically, that premium -- or historically has been in the $4 to $6 range, with some unique changes to this market. It's selling in the double-digit range, probably in the order of $12 premium to Brent today. So it's an asset that generates some significant free cash flow for Vermillion that we can redeploy elsewhere in the business. And again, we got into Australia in 2006, and we've been able to hold production fairly steady over time. So in closing, Vermilion has got a strong suite of assets that in a normalized commodity price environment will generate some significant free cash flow that we can reinvest in our business for optimum operational and financial performance of the company and, ultimately, cash returns to our shareholders. Thank you. And open for questions, Arun.

Curtis, thanks for participating in our conference. I did want to maybe begin a little bit around the resignation of Anthony Marino. And just talk a little bit more around what are some of the core business principles, as you highlighted in your presentation, that you think you got away from. And as you look to redirect the company back to some of the core business principles when the stock was really, really humming, what are some of the key balance sheet metrics that you look to get to before potentially going back to returning significant cash to shareholders through the dividend?

Yes. I mean Arun, I think I kind of alluded to it really at a high level. I mean obviously, I wasn't here, I wasn't in the boardroom, not privy to the discussions. But frankly, the key principle that we got away from was we allowed our leverage to climb to levels that really we're uncomfortable with. It was just a drifting apart of -- away from the key core principles that we outlined between Tony and between the Board, and they just felt it was time to make a change, bring back the focus that we had on the key business principles. And really, it's all about clean balance sheet and profitability, if I could sum it up in 2 words. And I think we kind of got away from that a little bit. So really near term, the focus is going to be on the balance sheet. We outlined our metrics. We want to stay below 1.5x. And the reality is, if you keep a clean balance sheet, it allows you to operate your business through these downturns. And we did it in '08 with a financial crisis. We had a really clean balance sheet. We didn't have to change our business model or our approach to business at all. And again, when the price collapsed in '14, '15, we probably didn't have quite as much flexibility because our leverage was starting to climb at that point. And so we just know how important it is to keep a clean balance sheet.

Operationally, you talked about European gas prices. Could you talk about some of the potential shock absorbers that you guys have in terms of your hedge profile or the things that can mitigate the impact to European gas? And what are some of your expectations around pricing? Obviously, we're in a tough condition right now just because of COVID-19, the demand collapse. But how do you see that kind of playing out over the next few quarters in Europe?

On Slide 15 of our deck, we do show you the hedge book that we've got on the European gas. It's a combination. We use different products in the hedge market in order to achieve our objectives of kind of providing us with some downside production. On the European gas side, we've got a number of 3-ways in place, as you can see. We've got a few collars and a couple of swaps, but we focus on the 3-ways because in the price environment that we've been in, we've kind of felt that that's been the most effective vehicle for hedging our commodity there. So we've maintained, I think, over time, a fairly strong hedge book particularly in -- with respect to our European gas. That production is fairly steady. We really like the premium that we've been able to achieve in the market. And so we've locked that premium in. So we do have a decent hedge position for 2020. We're 60% hedged for '21. It's all 3-ways, as you can see. Again, as I mentioned, it's because of it's the product that we see the most effective in the current environment. And we'll continue to hedge this product as we see fit. So we do try to protect ourselves to some of the downside on all of our products, subject to where we see the markets and how effective we see the opportunity being available to us.

Curtis, you outlined in your slides the ability of the company to generate some free cash flow to improve the balance sheet. Have you guys looked yet at -- obviously, we have strip pricing of what Vermilion could potentially do under some different sensitivities or scenario analysis in '21 at current strip pricing in terms of just thoughts on production and potential free cash flow generation next year. I know you haven't guided, but I'd love to hear some at least on what's on your thoughts.

Yes. Arun, we run sensitivities on the current year, on the forward year. We run a long-range plan where we can run sensitivities. We do that on a consistent basis. What I would say about '21 is we haven't shared any of that because it's a pretty soft plan at this stage, right? Our teams are focused on putting a current budget in place. They extend that out. But as they get past the current year, those numbers get a little softer and they're not something that we'd be in a position to share with confidence, right? So yes, we are certainly monitoring that. We're running various sensitivities. But we're really just going to get into the nuts and bolts at '21 here in the coming months and to see what we can do.

Yes. And again, Vermilion for many, many years has been one of the leaders in returning cash to shareholders. And Vermilion, like many of your peers, have taken some actions on the dividend just given the magnitude of the demand collapse with COVID-19. And so what color would you give to investors around the potential or how the Board is thinking about potentially reestablishing the dividend on a monthly or a recurring basis?

Yes, Arun. I believe that -- I mean I've been here for 3 weeks, so I haven't got a real good pulse on the Board. But Lorenzo have chatted a number of times, obviously, and he's got a pretty good pulse. So I think my message is pretty good. We do want to get back to the return to shareholders. Absolutely. I think it's a critical component for our business going forward for the long-term value creation for Vermilion. It's just it's going to take a little bit of time. We got to get the balance sheet in better shape before we do that. We don't have to get to our absolute metric of debt at 1.5x or less. But we have to be in a position where we're comfortable that we're going to get there, and we're comfortable in the commodity price environment that we're operating in. And in fairness to Vermilion here this spring, I mean, the reality is the impact of COVID and the result -- the subsequent oil price war was really unprecedented to have 2 of those type of events occurring at the same time. And I've been in the business a long time. I can't recall seeing those types of things happen at the same time, and that kind of demand destruction occurring in such a short period of time.

Yes, I think it's unprecedented. And the only analogy I could think of is in the 1980s, which is also a difficult time.

Yes. I was there. I was -- that was part of -- alluding to that, it didn't -- it wasn't bad as this. It really wasn't.

I'm from the state of Texas and the mantra in Texas in 1984 was stay alive until '85. So that was a difficult time, I recall. Shifting gears a bit. How are you and the Board thinking about the portfolio? I know you've only been back for a month, less than a month, so perhaps an unfair question. But just broadly, how you think about the portfolio. Obviously, you're here for 15 years until 2018, so you played a big part in the portfolio. But just broadly, thoughts on the portfolio.

Well, yes. Broadly thinking, we really like the portfolio. We like the diversification. It gives us -- I take you back to the commodity price slide where we show you the gas prices relative to North America and our liquids slate of pricing, very attractive. We generate some significant free cash flow in our European operations. Australia, in Canada and now the U.S., we're hoping to build it there. So we really like the suite as we sit today. One of the things that we do want to do though is we do want to take a hard look at the assets, and we'll do that over the next 12 to 18 months. And should we be doing something with any of our assets, we don't think so at this stage, but that's an assessment that we want to make. We don't anticipate any asset sales at the time, and -- but you never say never. And once we get comfortable with what we've got and the opportunity base that we've got in front of us, then we can make the appropriate decisions.

Just a question just to dovetail on that question is just on A&D activity. Vermilion historically has been an upstream company that's had a leverage strong relationship with major oil companies, and they've been very comfortable monetizing or transacting with Vermilion just given the company's approach to ESG and just being a good partner in that kind of A&D kind of situation. How are you guys thinking about A&D and potentially doing a countercyclical kind of investment in the nature of the cycle?

Well, we continue to like A&D. I mean it's -- as you said, we've done some really good transactions with some of the majors to establish our core positions. If there was an opportunity that came along, we're certainly going to look at that. But I think, to be honest, in this current environment with the balance sheet where it's at, it's going to be a challenge for us to do something. It's not to say we won't, and it's not to say we won't look. But it's probably not a near-term focus. But certainly, it is part of the overall strategic direction for Vermilion. We still want to take advantage where we can.

Yes. And just my last question. You highlighted some intriguing potential in Croatia. Could you just quickly -- and then we're running out of time, just talk a little bit about that -- the implications of that to Vermilion?

Well, yes. I think it provides us with a platform in Europe where we can grow that provides some meaningful growth to the company. Again, we're early days yet. We need to understand what we've got. We need to understand the strategy and how much capital it's going to take. And again, we have to weigh that against how much capital can we afford to put into it in the current price environment, right? So -- but nonetheless, we do have the land secured and we have tenure. And so we think it's an exciting piece of business for us as we go forward.

Great. Curtis, on behalf of the JPMorgan energy team, we thank you and Kyle and the team for participating in our fifth annual conference. And we obviously really appreciate the continued support of JPMorgan by Vermilion. And again, have a terrific rest of the day. And thanks for all the investors for listening in today.

Well, thank you, Arun, for your support. We really appreciate it, and look forward to working with you as we move forward.

Great. Thanks a lot.