Spin-off firms can provide investors with an early opportunity to invest in a company before correct financials reflect its potential. Vitesse Energy (NYSE:VTS) debuted with a small capital base (30 million shares outstanding), excellent free cash flow ($61 million in the first quarter), and a $2.00 annual dividend (paid quarterly). An investor may check this company’s first quarter financials only to discard further study owing to onerous one-time charges unless they realize the “loss” is merely temporary and big incoming cash is on the way.

Years ago, I read a book on spin-offs that noted the great profitability of certain new companies that began with a favorable financial structure, considerable management stake, and a successful business model. This one meets all of the requirements.

An energy company suffers severe price fluctuations, and Vitesse is not immune, but the company is robust enough to survive a slump as a non-operating corporation with large cash flow and limited debt. Furthermore, the substantial yield will incentivize investors to hold their holdings. Any decline in the stock price, which is currently $23.76 per share, will only raise the dividend payout ratio. Currently, the dividend return on VTS stock is 8.29%, ranking well among all public businesses.

A non-operational energy firm is reliant on third-party drillers looking for new drilling wells with the highest return on investment. Refrac technology used in the Williston Basin (Bakken) is lowering costs and increasing oil output for drillers, while also benefiting mineral rights owners. Energy investor reports abound, with severe limits on exploration spending because investors want capital returns, including dividend payments. Investor pressure on publicly traded businesses limits new good exploration but appears to be luring drillers into “reworking” old wells. The reason for this anomaly is that refract development costs less than drilling a “new” well while producing more oil and generating greater net revenue. Both the driller and the non-operating owner (Vitesse) benefit. The overall macro environment for oil supply is constrained, owing to years of cautious exploration. Occidental Petroleum (OXY) might be seen as a barometer of oil exploration constraints. The CEO specifically emphasizes that the company will maintain output levels that provide enough returns to shareholders.

The company maintains a proprietary software tool to analyze optimal investment selections, which includes a large database on well productivity potential, allowing flexibility in capital deployment for maximum returns on work-over locations. The Williston basin (Bakken play) in North Dakota has the most acreage under their control, with one out of every three active wells located there. The rebound in good activity is visible here.

Barrels of Energy (including the years preceding the public debut)

2020-9,655 boe per day production costs/ $41.7 million

2021-9,899 boe per day production costs/ $45 million

Costs of production in 2022: 10,376 boe per day/$49.3 million

2023 -11,524 boe per day (through the first quarter)/$9 million production costs (first quarter) (data from firm SEC filings)

Energy production increased by 25% in the first quarter of 2023 compared to the same period in 2022, while revenue decreased by 11% due to lower natural gas prices. Cash flow from operations increased from $27 million to $39 million in the previous quarter. The corporation does not hedge its relatively tiny 20% natural gas production (based on sales) for 2023, although it hedges around 30% of oil production. This technique protects the annual dividend of $2.00 while providing exposure to rising oil prices. Many analysts anticipate the oil market will be undersupplied in the second half of 2023, and OPEC has now announced additional production cutbacks of around 1 million barrels per day. Furthermore, the United States has yet to replenish the strategic reserve with around 300 million barrels.

Cash Flow From Operations

$76 million in 2020

$100 million in 2021

$147 million in 2022

(Projected)$160 million in 2023. (4 times the figure from Q1)

If production continues to improve in line with first-quarter performance, I anticipate Vitesse might generate $240 in free cash flow in 2023. Investors tend to be bearish on energy businesses right present, maybe due to concerns about the possibility of a recession. A recession is a distinct possibility, but if physical oil supply continues to fall short of demand in the second half of 2023, oil prices will likely remain over $80 per barrel. Even during a recession, inflation can persist. Investors should also keep in mind that China and India are still growing, which will help to stabilize global demand even if the US economy falters. As a contrarian, I look for chances that others may overlook because they contradict popular wisdom. I believe VTS stock can easily reach $30 per share, valuing it at less than 5 times my free cash flow figure.

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