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Vermilion Energy Inc. Second Quarter 2022 Results

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   |    Thursday,August 11,2022

Vermilion Energy Inc. reported its second quarter 2022 results.

Highlights:

• Q2 2022 fund flows from operations (“FFO”)⁽¹⁾ was $453 million ($2.75/basic share)⁽²⁾ and free cash flow (“FCF”)⁽³⁾ was $340 million ($2.07/basic share)⁽⁴⁾, an increase of 16% and 12%, respectively from the prior quarter. The increases were primarily due to higher commodity prices. Cash flow from operating activities was $530 million in Q2 2022, including the impact from asset retirement obligations settled and changes in non-cash operating working capital.
• Pro forma Q2 2022 FFO and FCF incorporating the incremental 36.5% ownership in Corrib was $536 million ($3.26/basic share) and $422 million ($2.56/basic share), respectively. As a reminder, all FCF from the Corrib acquisition accrues to Vermilion as at January 1, 2022 and will be netted off the approximate $600 million purchase price at the time of closing which we expect to occur in Q4 2022.
• With clear line of sight to achieving our next mid-cycle⁽⁵⁾ debt target, we are pleased to outline our formal return of capital framework. We intend to return an increasing amount of capital to shareholders as debt levels decrease using a debt grid to guide near-term Return of Capital allocation decisions.
• In conjunction with our Q2 2022 release, we announced a 33% increase to our Q3 2022 quarterly cash dividend to $0.08 CDN per share which equates to an annual dividend of $0.32 CDN per share, or approximately $53 million. Dividends will remain a key component of our return of capital framework as we seek to provide shareholders with a resilient and increasing base dividend; however, we will limit the annual cash dividend to approximately 10% of our mid-cycle FFO.
• Based on our Return of Capital Allocation Grid, recent commodity strip⁽⁶⁾ and internal estimates, we anticipate returning up to 25% of FCF in 2H 2022 and up to 50% – 75% of FCF in 2023. We will consider various options to return capital; including share buybacks, regular and special dividends and a potential substantial issuer bid. Based on our review of a number of valuation data points, we expect the majority of the incremental capital return to be in the form of share buybacks initially.
• In early July 2022, we announced the approval of a normal course issuer bid (“NCIB”) for the purchase of up to 16,076,666 common shares, representing approximately 10% of Vermilion’s public float as at June 22, 2022. To date, we have repurchased 1.25 million common shares for $35 million.
• Net earnings were $363 million in Q2 2022, an increase of 28% from the prior quarter due to higher commodity prices and net hedging gains.
• Cash flow used in investing activities totaled $613 million in the second quarter including exploration and development (“E&D”) capital expenditures⁽⁷⁾ of $113 million and acquisition capital of $522 million.
• The Leucrotta acquisition closed on May 31, 2022 and the assets have been successfully integrated into Vermilion. We are now focused on completing the 6-well Montney pad that was drilled in Q2 2022. The Mica asset significantly increases the depth and quality of our North American inventory and is expected to add multiple decades of development that will enhance FCF to the business.
• Long-term debt in Q2 2022 was $1.5 billion and net debt⁽⁸⁾ was $1.6 billion, resulting in our net debt to trailing FFO ratio decreasing to 1.1 times⁽⁹⁾ compared to 1.2 times in the prior quarter.
• Production in Q2 2022 averaged 84,868 boe/d⁽¹⁰⁾ a decrease of 2% from the previous quarter, primarily due to planned and unplanned downtime.
• Production from our North American operations averaged 58,027 boe/d⁽¹⁰⁾ in Q2 2022, an increase of 3% from the prior quarter primarily due to the Leucrotta acquisition, which closed on May 31, 2022.
• Production from our International operations averaged 26,840 boe/d⁽¹⁰⁾ in Q2 2022, a decrease of 9% from the prior quarter primarily due to natural decline, offshore drilling delays and unplanned downtime in Australia.
• As a result of forest fire related downtime in France, offshore drilling delays in Australia, combined with inflationary pressure, we are increasing our 2022 capital budget by $50 million to $550 million. Annual production guidance, excluding the Corrib acquisition volumes, remains unchanged at 86,000 to 88,000 boe/d. Our exit rate forecast of 95,000 to 100,000 boe/d, including the Corrib acquisitions volumes, also remains unchanged.
• We released the annual update to our online sustainability report in July 2022. Notable highlights include the decrease in our Scope 1 emission intensity to.018 tCO2e per throughput operated boe, in line with our target to reduce our 2019 baseline of.019 tCO2e per throughput operated boe by 15% to 20% by 2025, and coverage of our Corrib Biodiversity Action Plan achievements.

Vermilion commented to shareholders: "Global commodity prices continued to strengthen through the second quarter, driving another quarter of record fund flows from operations (“FFO”) and free cash flow (“FCF”) for Vermilion. FFO was $453 million (cash flows from operating activities of $530 million), representing a 16% increase over the prior quarter. Exploration and development (“E&D”) capital expenditures were $113 million in Q2 2022, resulting in quarterly FCF of $340 million. Free cash flow in Q2 2022 was used to partially fund the Leucrotta acquisition which closed on May 31, 2022. The remainder of the Leucrotta purchase price was funded with debt which resulted in a slight increase in Q2 2022 net debt to $1.6 billion; however, with the increase in FFO our net debt to trailing FFO ratio decreased to 1.1x.

"We have successfully integrated the Leucrotta assets and assembled a Mica asset team which is now focused on completing the 6-well Montney pad that was drilled in Q2 2022. We are excited to have these assets in our portfolio and look forward to scaling up development in the years ahead. The Mica asset significantly increases the depth and quality of our North American inventory and is expected to add multiple decades of development and enhance FCF to the business.

"Closing of the Corrib acquisition continues to progress as we move closer to obtaining all remaining partner and government approvals. We expect the transaction to close in the fourth quarter with an estimated closing cash payment in the range of $100 to $150 million after adjusting for the FCF accrued throughout the year. Pro forma Q2 2022 FFO and FCF incorporating the incremental 36.5% ownership in Corrib was $536 million and $422 million, respectively.

"We remain on track to achieve our next debt target of $1.2 billion by the end of 2022, and with this clear line of sight we are pleased to outline our formal return of capital framework which will see an increasing proportion of FCF returned to shareholders as debt levels decrease. Over the past two years we have been focused on balancing debt reduction and portfolio enhancement, all with the goal of maximizing value and the return of capital to our shareholders over the long term. Vermilion is in a very strong position from both an asset base and financial perspective. We announced two strategic acquisitions over the past year, funded with free cash flow, and will have reduced debt by approximately $1 billion, relative to Q2 2020 debt levels, by the end of this year⁽¹⁾. While we will continue to keep a close eye on debt and reduce it even further to ensure we maintain a strong balance sheet through all commodity cycles, we are now in a position to increase our return of capital to shareholders. We are confident that our globally diversified asset base combined with our disciplined approach to capital allocation will generate value for our shareholders over the long-term. Further details on our return of capital framework is outlined below."

Return of Capital

Vermilion declared a quarterly cash dividend of $0.06 CDN per share in Q2 2022 which was paid on July 15, 2022. With two strong quarters now behind us and a clear line of sight to achieving our next mid-cycle⁽²⁾ debt target of $1.2 billion, we are now in a position to return a greater proportion of free cash flow to our shareholders. Vermilion has a long history of returning capital to its shareholders primarily through dividends. Dividends will remain a key component of our return of capital framework as we seek to provide shareholders with a resilient and increasing base dividend; however, we will limit the annual cash dividend outlay to approximately 10% of our mid-cycle FFO. In conjunction with our Q2 2022 release, we announced a 33% increase to our Q3 2022 quarterly cash dividend to $0.08 CDN per share which equates to an annual dividend of $0.32 CDN per share or approximately $53 million based on the current number of shares outstanding. At this dividend per share level, we have significant capacity to increase the base dividend and plan to provide ratable increases over time.

In addition to strengthening our balance sheet, Vermilion has made other structural improvements to its business by increasing our International production weighting through European natural gas exposure while also enhancing our North American inventory with a high quality long-life Montney asset. These structural improvements, combined with the strong fundamental outlook for global commodities will further underpin our ability to return capital to shareholders. The amount of FCF available for return of capital will increase as debt levels decrease based on the illustrative grid outlined below. This grid is not intended to be prescriptive quarter-to-quarter but will be used as a tool to guide near-term Return of Capital allocation decisions while taking into account other capital requirements such as further debt reduction, asset retirement obligations and acquisitions.

Based on our Return of Capital Allocation Grid, recent commodity strip⁽³⁾ and internal estimates, we anticipate returning up to 25% of FCF in 2H 2022 and up to 50% – 75% of FCF in 2023 while reducing debt to a target of $850 million by the end of 2023, which implies an undrawn $1.6 billion credit facility. We will consider various options to return capital; including share buybacks, regular and special dividends and a potential substantial issuer bid. Based on a number of datapoints reviewed, we expect the majority of the incremental capital return to be in the form of share buybacks initially. In early July 2022, we announced the approval of a normal course issuer bid (“NCIB”) for the purchase of up to 16,076,666 common shares, representing approximately 10% of Vermilion’s public float as at June 22, 2022. To date, we have repurchased 1.25 million common shares for $35 million. We look forward to providing continued updates on our return of capital initiatives through the second half of this year and throughout 2023 as we carefully weigh capital allocation decisions against various uses of excess free cash flow with a view of acting in the long-term interests of shareholders.

Q2 2022 Operations Review

North America

Production from our North American operations averaged 58,027 boe/d⁽⁴⁾ in Q2 2022, an increase of 3% from the prior quarter primarily due to the Leucrotta acquisition which closed on May 31, 2022. Drilling and completion activity in west-central Alberta and south-east Saskatchewan was limited during the second quarter due to spring breakup. During the second quarter, we completed one (1.0 net) well and brought on production one (0.6 net) condensate-rich Mannville natural gas well in west-central Alberta, and we drilled one (1.0 net) well and completed two (2.0 net) wells in south-east Saskatchewan. Following the announcement of the Leucrotta acquisition in late March 2022, we assembled our Mica asset team and focused on integrating the assets and working closely with the Leucrotta team in drilling the first six (6.0 net) well Montney pad. Drilling was successfully completed during the second quarter and the team is now focused on completion activities. While we remain optimistic that an agreement on natural resource activity reviews will be reached between the BC Government and the Blueberry River First Nations in due course, our team has a plan to continue drilling on the Alberta side of the Mica property in 2023 should we see further delays in permit approvals.

In the United States, we drilled four (3.8 net) wells of our planned six (5.8 net) operated Turner wells and completed two (2.0 net) wells during the second quarter. Three (2.8 net) wells are two-mile lateral wells which are significantly more economic than one-mile laterals. One (1.0 net) well was brought on production during the second quarter while the remaining wells will be completed and brought on production during the third quarter. In addition, one (0.4 net) two-mile non-operated Turner well is planned for drilling in Q4 2022.

International

Production from our International operations averaged 26,840 boe/d⁽⁴⁾ in Q2 2022, a decrease of 9% from the prior quarter primarily due to natural decline and offshore drilling delays in Australia. In Australia, the drilling of our two-well program was delayed by approximately one month due to unexpected maintenance and repairs on the third-party contracted rig. Drilling commenced late in the second quarter and is expected to finish in early September with production to start shortly thereafter. In Europe, much of our activity during the second quarter was focused on preparing for our 2H 2022 drilling campaign which will include two (1.1 net) wells in Netherlands, three (3.0 net) wells in Hungary and two (2.0 net wells) in Croatia.

Outlook and Guidance Update

Our Q3 2022 capital program is well underway as we finish up the drilling program in Australia, complete and tie in the remaining Turner wells in the US, execute our south-east Saskatchewan drilling program and complete the 6-well Montney pad at Mica. In Europe, we are making final preparations for an active drilling campaign to commence in the third quarter and continue through the fourth quarter. Early in the third quarter, a forest fire near our Cazaux field in southern France resulted in approximately 1,500 bbl/d of production being temporarily shut-in which will impact Q3 production in France.

Our Q3 2022 production will include a full quarter contribution from the Leucrotta acquisition and new production from the US and south-east Saskatchewan drilling programs; however, these volumes will be partially offset by the Australia drilling delay and fire related downtime in France. Taking all this into account, we expect Q3 2022 production to be in-line with Q2 2022.

As a result of forest fire related downtime in France, offshore drilling delays in Australia, combined with inflationary pressure, we are increasing our 2022 capital budget by $50 million to $550 million. We are maintaining our annual production guidance of 86,000 to 88,000 boe/d, excluding the Corrib acquisition volumes. We plan to update our production guidance once we have greater certainty on timing of the Corrib close. Our exit rate forecast of 95,000 to 100,000  boe/d, including Corrib acquisition volumes, remains unchanged.

Commodity Hedging

Vermilion hedges to manage commodity price exposures and increase the stability of our cash flows. In aggregate, as of August 9, 2022, we have 36% of our expected net-of-royalty production hedged for the remainder of 2022. With respect to individual commodity products, we have hedged 64% of our European natural gas production, 20% of our oil production, and 41% of our North American natural gas volumes for the remainder of 2022, respectively.