Spin-Off companies can offer investors an early opportunity to stake a position long before accurate financials reveal company potential. Vitesse Energy (NYSE:VTS) launched with a tight capital base (30 million shares outstanding), strong free cash flow at $61 million in the first quarter, with a $2.00 outsized annual dividend (paid $.50 quarterly). An investor might scan this company’s first quarter financials only to dismiss further investigation-due to onerous one time charges, unless realizing the “loss” is temporary, while significant incoming cash lies ahead.
Years back I read a book on spin-offs, noting the high profitability from certain new companies starting with a favorable capital structure, significant management stake and a business plan fortified for success. This one fits each criteria.
An energy company faces volatile price swings, and Vitesse is not immune, but as a non-operating entity with significant cash flow and minimal debt-the business is strong enough to weather a downturn. Furthermore the significant dividend will serve to entice investors to retain their position. Any drop in stock price, currently at $23.76 per share, will only increase the dividend payout ratio. Currently the dividend return on VTS stock is 8.29% which places high in rankings for all public companies.
A non-operating energy business depends on 3rd party drillers who seek new drilling wells offering maximum return on their investment. Refrac technology deployed in the Williston Basin (Bakken) is delivering lower costs while producing greater oil output for drillers, with benefits flowing to mineral rights owner in parallel. Reports from energy investors abound with strict limitations on exploration spending since investors desire capital returns, including dividend payments. Investor pressure on public companies limits new well exploration but also appears to be attracting drillers into “reworking” of existing wells. The reason behind this anomaly is refrac development costs less than drilling a “new” well, while delivering more oil and larger net revenue. Both driller and non-operating owner (Vitesse) reaps the reward. The overall macro environment for oil supply is tight, due in large part to years of restrained exploration. One can look to Occidental Petroleum (OXY) as a bellwether on oil exploration restraint. CEO explicitly states the company will maintain production at levels that deliver proper returns to shareholder.
The company maintains a proprietary software program to evaluate optimal investment decisions incorporating an expansive database on well productivity potential, allowing discretion on employing capital for maximum returns on work-over locations. The Williston basin (Bakken play) in North Dakota hosts their largest acreage of ownership, on which 1 of every 3 operating well resides. The rebound in well activity can be seen here.
Barrels of Energy (Including years prior to public debut)
2020-9,655 boe per day/$41.7 million production costs
2021-9,899 boe per day/$45 million production costs
2022-10,376 boe per day/$49.3 million production costs
2023 –11,524 boe per day (thru 1st quarter)/$9 million production costs (Q1) (Information from company SEC filings)
In the first quarter 2023 energy production surged 25% compared to Q1 of 2022 while revenue dipped 11% due to lower natural gas prices. Cash flow from operations increased to $39 million from $27 million quarter over quarter. The company does not hedge its relatively small 20% natural gas production (based on revenue) while hedging approximately 30% of oil production for 2023. This strategy protects the $2.00 annual dividend, while allowing exposure to increased oil prices. Numerous analysts believe the oil market is under supplied for the second half of 2023, and OPEC just announce further production cuts at approximately 1 million barrels per day. Furthermore the USA has yet to replace approximately 300 million barrels from the strategic reserve.
Cash flow from operations
2020-$76 million
2021 $100 million
2022 $147 million
2023 (Projected)$160 million. (4 times Q1 figure)
I believe Vitesse could deliver $240 in free cash flow in 2023 if production continues to progress in line with first quarter results. Investors appear to be negative toward energy companies right now, perhaps worrying about recession possibilities. A recession is a definite possibility, but if physical oil supply remains below demand in the back half of 2023, we will likely continue to see an oil price above $80 per barrel. Inflation can persist even amidst a recession. Investors must also keep in mind that China and India continue to grow, which will stabilize worldwide demand even if the USA economy falters. As a contrarian, I look for opportunities that others may run contrary to conventional thinking. I believe VTS stock can easily hit $30 per share, which would rate it at less than 5 times my free cash flow figure noted.
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