Have you ever had to grit your teeth and “hang in there” while one of your holdings works through an industry trough? That’s where we’ve been at with USA Compression Partners LP (USAC) for the past few quarters. As US drilling declined and picked back up, USAC, the leading US pure play compression company, has seen its DCF and distribution coverage falter due to a lagging effect – new compression demand tends to lag increased drilling by a few quarters. Its price/unit also suffered.
Fortunately, USAC has a very supportive general partner, USAC Compression Holdings LLC, which has continued to reinvest 50% of its quarterly distributions in USAC. This has allowed to maintain a “cash distribution coverage ratio” above 1x. (Left column is Q2 ’17; right column is Q1 ’17):
(Source: USAC site)
Here’s how this has played out over the past four quarters – the DCF/Distribution coverage has below 1x, but due to the $ 6M-plus that has been reinvested each quarter, they’ve been able to maintain their $ .525 quarterly payout with a cash coverage ratio averaging 1.055x:
Management reaffirmed it’s 2017 guidance on the Q2 earnings release. We’ve updated this table with the actual distribution figures from Q1-Q2, to compare them to the guidance figures.
If USAC maintains the current level of total distributions, their traditional DCF/Distribution coverage will be in a range of .84x to .95x, according to the DCF guidance range.
However, if their GP continues to reinvest its distributions in Q3 and Q4 ’17, USAC’s cash distribution coverage ratio will be in a 1.06x to 1.20x range.
In this table, we compare the actual Q1-2 ’17 EBITDA and DCF figures vs. the pro-rated 2017 guidance figures. So far in 2017, management has achieved the low end of its guidance in both DCF and EBITDA.
However, there are reasons to believe that this will improve in the second half of 2017 and in 2018, which we’ll detail in the Earnings and Back To The Future sections further on in the article.
USAC’s next distribution should have an ex-dividend date sometime in late July. It pays in the usual Feb/May/Aug/Nov LP cycle. Management has maintained a $ .525 quarterly payout since August 2015, which is 23.53% above its targeted minimum quarterly distribution.
You can track USAC’s price and current yield in the Basic Materials section of our High Dividend Stocks By Sector Tables.
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In Q2 ’17, EBITDA was down slightly vs. Q2 ’16, while DCF fell -11% due to “some acceleration in maintenance activities during the quarter, as demand for certain idle units in our fleet increased more than expected.”
OK, so DCF was down due to increased demand – not a totally negative scenario – they needed to spend to prepare more machinery for future service.
Sequentially, this was USAC’s best EBITDA figure since Q2 ’16. Fleet utilization was also up, as they noted on the Q2 earnings call: “Our average horsepower utilization for the second quarter was 91.2%, up nicely from 88.2% in Q1, continuing the upward movement of recent quarters.”
“We increased our core compression service revenues by about 5% over the first quarter and achieved a gross margin of over 67%, which was also up from the first quarter.”
Here’s what investors have had to deal with over the past 4 quarters, in return for receiving the steady $ .525/unit quarterly payout – flat revenue, EBITDA down -6%; DCF down -10%; DCF Distribution Coverage down -20%; and unit growth of 12.43%.
Like many of the companies we cover in our articles, USAC has long-term fee-based contracts. Management has also done a good job of keeping bad debt at a minimum, (less than 0.07% over the past 12 years), through partnering with larger, solid counter-parties, and maintaining long-term relationships:
We wouldn’t be braving these headwinds over the past year if it wasn’t for management’s long-term track record of growth – EBITDA CAGR of 15%, Revenue CAGR of 16%, with margins above 50%, (and, of course, the steady distribution).
In addition, USAC has a long history of weathering natural gas cycles. Due to the critical need for its compression services – producers need compression to move natural gas through the pipeline system. This company isn’t going away anytime soon:
Another factor which makes compression services “sticky” over the long term is the profile of natural gas wells in shale plays, which not only need more compression but also tend to have a long 20-year-plus life, after stabilizing.
Management has grown USAC’s asset base considerably, but also made a savvy move in 2016 and 2017 – they cut capex substantially, in response to the downturn:
(Source: USAC site)
Back To The Future:
So, can USAC return to growth, or, at least get to better distribution coverage in the second half of 2017 and in 2018? Management thinks so. On the Q2 earnings call, they said the following:
Looking back on the quarter, we experienced increased activity on the part of our midstream and large E&P customers. This increase in demand has led to tightening in availability of certain types and classes of equipment, leading to increased fleet utilization, both for USA Compression as well as select sector peers. USA’s larger horsepower fleet utilization is now back to levels virtually the same as before the industry decline, in the mid-90% area.”
We also improved visibility regarding demand for our services and corresponding contracting activities, well into 2018. Given this tightness, we have increased the monthly service fees we charge on many types of equipment we use to provide our services.” (Emphasis ours)
During the second quarter, we also saw strong contracting activity, signing new contracts for upwards of a 160,000 horsepower.”
As of the end of the second quarter, we expect to take delivery of approximately 70,000 new-build horsepower in the second half of 2017, part of approximately a 125,000 total horsepower that is already contracted and expected to start in the back half of the year, further increasing utilization as well as revenues and cash flow.”
For 2018, we’ve already contracted to build and take delivery of approximately a 150,000 horsepower throughout the year with the majority already spoken for by our core customers.”
able to see increasing cash flows and increasing activity over the next — the rest of this year and well into 2018. We think we kind of grow back into a coverage level that’s a little more attractive than where we are now.”
Another positive note was that management doesn’t see any more unit dilution in the near future: “We are not looking at any need for equity and we think that the business kind of naturally delevers over the course of the next two, four-plus quarters.” (Source-Q2 earnings call)
Management also addressed the changes which have been evolving in the industry on the Q2 earnings call:
“There is a fundamental shift occurring in the oil and gas industry as certain shale plays move from the exploration/exploitation mode into the development mode, driven in many cases by our larger upstream customers. This moment toward massive mining type, manufacturing oriented project results and initial production volumes in many cases approaching those of large offshore production platforms.”
“Our business is driven by natural gas demand and production. As the industry has evolved into these larger projects, our large horsepower fleet sits right in the middle of it all. We continue to see significant activity by our customers, especially in the Permian and Delaware basins, and it is all focused on the very largest compression units in our fleet.”
(Source: USAC site)
What’s causing the increased demand for compression? US producers are adding rigs in key areas – excepting the Marcellus, which was up 73% from the trough, all of the areas listed below had rig counts up by triple digits as of 8/11/17.
(Source: USAC site)
As management noted in the earnings call, “The factors driving natural gas demand and the associated need for increased domestic natural gas infrastructure remain firmly in place – exports to Mexico, LNG exports, industrial demand, and gas-fired electric generation.”
(Source: USAC site)
As we noted earlier, USAC isn’t currently covering its distributions in a traditional DCF/distribution model – its general partner, USAC Compression Holdings LLC, has been supporting the distribution by electing to reinvest 50% of its distributions into the company’s DRIP plan, which affords USAC more cash to continue paying out that $ .525 distribution every quarter. If the general partner decides to stop reinvesting in the near term and USAC’s anticipated earnings growth doesn’t emerge, management may be forced to cut the distribution.
Hurricane damage – Hurricane Harvey caused some wells to be shut in within the Eagle Ford area – the net downside is unknown as of yet. “The shut-in wells also have disrupted natural gas pipeline flows into Mexico, one of the biggest purchasers of Eagle Ford gas, and caused prices to spike there.” (Source: mysanantonio.com)
However, a 9/11/17 update from Forbes said that “A variety of midstream companies have provided updates on operations and the punchline is there has been very minimal damage and operations have either restarted or in process of restarting at various facilities. This is consistent for producers, with crude oil and natural gas production coming back on-line as well.” (Source:forbes.com)
USAC is now 12.6% below analysts’ current $ 17.60 price target, and 28% below the $ 20.00 high price target.
USAC’s 13.44% yield dwarfs the Oil & Gas Equipment & Services industry’s average 1.67% yield, while its Price/Book is considerably lower.
The industry isn’t known for high ROA and ROE figures – the amount of heavy equipment needed implies a large depreciation and amortization charge vs. net income, which makes USAC’s tiny ROA and ROE figures look good by comparison. Its Operating Margin is also much higher than broad industry averages, while its Debt/Equity level is much lower.
Debt and Liquidity:
Management commented on current leverage on the Q2 earnings call – “Outstanding borrowings under our revolving credit facility as of quarter-end were $ 725 million, resulting in a leverage ratio of 4.94 times, consistent with the first quarter and well within our covenant level of 5.5 times.”
The $ 1.1B credit facility matures in 2020. They had ~ $ 375M available as of 6/30/17.
(Note: we used trailing EBITDA to derive a 5.04x ratio, whereas management uses Q2’s EBITDA annualized vs. debt, to come up with their 4.94x figure.)
We continue to rate USAC a long-term buy. This is a company which has weathered numerous Energy cycles, and we feel that they will do so once again. Meanwhile, income investors receive a very attractive quarterly payout.
All tables furnished by DoubleDividendStocks.com, unless otherwise noted.
Disclaimer: This article was written for informational purposes only, and isn’t intended as personal investment advice. Please practice due diligence before investing in any investment vehicle mentioned in this article.
Disclosure: I am/we are long USAC.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.