Analysts at Scotiabank have upgraded Vermilion Energy Inc. on the basis that rising European natural gas prices and a declining stock price should set the company up for higher cash flow and a more attractive valuation.

Given [Vermilion’s] share price has fallen roughly in line with its peer group over the past couple of weeks, the relative valuation of [Vermilion] has improved materially,” Jason Bouvier, an analyst at Scotiabank Global Equity Research, said in a note Monday. 

Between 40 and 45 per cent of Vermilion’s cash flow comes from European gas prices, which have soared about 50 per cent recently, Bouvier said. 

He raised his recommendation to sector outperform (the equivalent to a buy) from sector perform (equivalent to a hold) and maintained his 12-month price target of $36.00 per share. 

Over the same time period when European gas prices have risen, American benchmark crude West Texas Intermediate has fallen about US$14 per barrel from its recent high. 

As oil has declined, so have the share prices of many energy-producing companies, including Vermilion, even though it’s mainly exposed to natural gas rather than crude oil. 

Vermilion’s share price “doesn’t reflect significant European gas exposure,” Bouvier said. 

Along with higher natural gas prices, the company is poised to benefit from its production hedges rolling over. 

“Currently, the company has about 40 per cent of its production hedged in 2022. This falls to 10 per cent in 2023. No oil is hedged for 2023 and North American gas is hedged at higher prices than in 2022,” he said. 

He added that even though prices for some major commodities are expected to fall next year, “[Vermilion’s] cash flow actually increases from $2.2 billion in 2022 to $2.4 billion in 2023 (up 10 per cent).”

That bump in cash flow will not only allow Vermilion to potentially become debt-free sooner, Bouvier said it could also mean the company will share more of its wealth with investors.  

“After hitting their debt target, the company will be in a good position to increase shareholder returns. We expect both increased dividends and [share buybacks] over the next one to two years,” he said. 

Vermilion reinstated its dividend in April after it suspended the payout at the onset of the pandemic as commodity prices crashed. The company currently pays a dividend of six-cents a share.