Maintaining a Generous Dividend:Warren Buffett's 9% Yielding Stock's Strategic Approach

Vitesse Energy (NYSE: VTS) is held by Warren Buffett’s Berkshire Hathaway and carries a dividend yield of 9% at the time of writing. So what’s left to think about before buying? As respected as Buffett is, it still makes sense to kick the tires before opening a position. In that spirit, I thought I’d look at what Vitesse is doing to make its dividend sustainable. It’s a vital part of what most investors seek in the stock, so here goes.

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Vitesse Energy’s dividend

The dividend clearly matters to management as it intends to return cash to shareholders through dividends and share buybacks. For example, management expects to “initially pay” quarterly dividends equivalent to $66 million (or $2 per share), and it has a share repurchase plan of up to $60 million.

According to Vitesse’s Securities and Exchange Commission (SEC) filings, its dividend policy is to “pay dividends out of distributable cash flow.” Vitesse defines this as “Adjusted EBITDA less interest expense and cash taxes.” For reference, Vitesse generated $167.6 million in adjusted EBITDA in 2022.

EBITDA stands for earnings before interest, taxation, depreciation, and amortization. Given that Vitesse intends to maintain a net-debt-to-adjusted-EBITDA multiple of less than 1, its interest payments are likely to be small (just $4.1 million in 2022 and $3.1 million in 2021) and taxes are usually a function of earnings, Vitesse’s distributable cash flow looks more than capable of covering its dividend.

Management did note that given the levels of capital expenditures in 2021 and 2022 (which come from its distributable cash flow), “we would not have been able to pay a $66.0 million distribution during the year ended November 30, 2021.” However, it also noted that going forward, paying a dividend is a priority and that it will sustain “production through maintenance capital expenditures.” In other words, it is out of a growth phase of capital expenditures and expects to move toward a relatively lower degree of capital spending — something that will facilitate generating cash flow to pay dividends.

The risk in Vitesse’s dividend

Time to start kicking some tires. The reality is that Vitesse is an oil and gas company, and its earnings and cash flow will always be somewhat dependent on energy price movements. As such, the $167.6 million in adjustable EBITDA in 2022 might not be the same in the following years.

That said, you don’t necessarily have to be uber-bullish on oil and gas to buy the stock. That’s because a big part of the case for buying the stock is based on management’s ability to identify and invest in profitable assets rather than relying on energy prices to go higher.

Three ways Vitesse manages risk

First, it’s not an owner/operator of assets. Instead, it invests in large numbers of wells (it has interests in 6,475 productive wells as of May 2023, with an average working interest of 2.7%) operated by experienced oil and gas companies and mainly within the Bakken oil field in North Dakota.

Second, as noted earlier, management aims for a net-debt-to-EBITDA ratio of less than 1. This frees up cash flow for use in investment or returns to investors.

Third, management uses a hedging strategy to reduce its oil price dependence. The use of hedging helps to turn Vitesse into more of a play on management’s ability to find productive oil-producing investments.

That said, hedging is always an imperfect science. The following table helps outline how management’s use of hedging impacted the average price of oil received by the company. As you can see below, the rise in oil prices through 2021 and 2022 resulted in hedging, reducing the average price received, while the fall in 2020 and the first quarter of 2023 led to hedging, helping improve the average price received. That’s pretty much what a hedging strategy is intended to do.

Metric	2020*	2021	2022	First Quarter 2023
Average realized oil prices before hedging	$35.22	$64.74	$94.16	$72.95
Average realized oil prices with hedging	$45.67	$58.16	$76.09	$74.02
Difference	$10.45	($6.58)	($18.07)	$1.07

Data source: Vitesse Energy. *Year ended Nov. 30.

Vitesse started 2023 with 31% of its expected oil production (to the end of 2024) hedged at $77.42 a barrel, but there’s nothing stopping management from hedging higher production percentages.

A sustainable dividend?

Keep in mind that Berkshire Hathaway didn’t actively acquire this position. It received a stake in Vitesse Energy when Jefferies Financial Group (NYSE: JEF) — a Berkshire holding — spun it out earlier this year.

Provided Vitesse’s experienced management team continues investing well, and the oil price stays relatively stable over the next few years (as it has been for the last six months), the company’s hedging strategy will likely succeed — sharp price movements will severely test hedging strategies.

While it’s a stretch to argue that Vitesse’s current dividend is sustainable over the long term, it still looks likely to be able to pay a handsome dividend to shareholders and remains attractive for income-seeking investors.