USAC - Archrock: Strong Q1 Demand Up 6% Yield Upside Potential

2023-05-21 09:15:00 ET

Summary

• Archrock, Inc. had 16.5% Revenue growth, 19% EBITDA growth, and 12% CAD growth in Q1 2023.
• Archrock is 27% below Wall Street analysts' lowest price target.
• It yields over 6% with robust 1.95X trailing common dividend coverage.

With Europe switching to U.S. liquefied natural gas exports, compression services have seen strong demand, which has been a boon to service providers like Archrock, Inc. ( AROC ).

Demand for U.S. natural gas is expected to continue to grow over the next several years, with LNG exports contributing most of the growth:

Profile:

Archrock, Inc. is a U.S. energy infrastructure company that specializes in natural gas compression services and aftermarket services. 77% of its operating fleet is used in the gathering and processing cycle stages, while the remaining 23% of its operating fleet is used in gas lift applications.

80% of AROC's 2022 revenues came from compression contract services, with the remaining 20% coming from aftermarket services. AROC is the biggest player in the outsourced contract operations part of the compression market, with a 29% market share.

However, 70% of the total compression market is formed by companies who own their own compression equipment - AROC capitalizes on this with its aftermarket services division.

We've been fans of companies with long-term contracts through the years - AROC fits this profile, with a ~4-year average contract length.

Management has concentrated on increasing the Horsepower size of its compression equipment fleet, as these larger units have better demand, and tend to be "stickier." Since the customer pays for any removal costs, they tend to stay with these bigger units longer. AROC's fleet age has improved by 11% since 2017, while its average horsepower size is up 97%:

AROC's long-term contracts shield it from commodity price swings, and provide a more even Adjusted EBITDA Margin through up and down energy cycles:

Earnings:

In Q1 '23, thanks to its bigger fleet and better demand, AROC had 16.5% Revenue growth, with 19% EBITDA growth. Cash Available For Distribution, CAD, was up 12%, while CAD/Share rose 15%. Contract operations gross margin increased from ~$99M to ~$108M. Management added nearly 70,000 HP in the quarter.

"We believe this significant inflection in Archrock's 2023 performance is created by market supply and demand fundamentals that support a robust multiyear outlook for natural gas, for compression and for Archrock. We expect the natural gas compression market to remain very tight for the foreseeable future. " (Q1 '23 Earnings Call , emphasis added.)

In full year 2022, Revenues rose 8%, while EBITDA was ~flat, and CAD fell 14.5%, due to the higher capex costs.

"Utilization, committed backlog total and idle fleet bookings all reached record highs during the year, exit fleet utilization increased to an all-time high of 93% and our operating horsepower grew by approximately 375,000 horsepower, excluding the 176 active horsepower we chose to sell as part of our fleet high-grading strategy." (Q4 '22 earnings call)

Mgt. raised the Q4 distribution from $.145 to $.15/share in Q1 2023. Although coverage was lower in 2022 vs. 2021, it was still an ample 1.9X. It averaged 1.9X for full year 2022, and it improved to 2X in Q1 2023:

2023 Guidance:

"Proactive debt reduction and a visible expected increase in future earnings give us line of sight to achieving a leverage ratio of below 4 times this year with our current near-term target debt-to-EBITDA ratio of 3.5 to 4 times." (Q4 call .)

Mgt. is expecting healthy increases in Net Income, 70%+, Adjusted EBITDA, 10%+, and CAD, 18%+, in 2023:

Dividends:

At its 5/17/23 closing price of $9.45, AROC yields 6.35%, with a 5-year dividend growth rate of 3.92%. It pays quarterly, and should go ex-dividend next on ~8/8/23, with an ~8/16/23 pay date:

Taxes:

Another plus for AROC investors is that it issues a 1099-DIV tax reporting form, not a K-1.

Profitability & Leverage:

As of 3/31/23, AROC had improved its ROA and ROE a bit, whereas its EBITDA Margin was somewhat lower. Debt/Equity leverage was similar to 2021, while Net Debt/EBITDA improved to 4.07X. EBTDA/Interest coverage fell to 2.44X. Mgt. is targeting sub-4X Net Debt/EBITDA leverage, which makes sense in this higher interest rate environment.

USA Compression Partners, LP ( USAC ), AROC's main competitor, uses more leverage than AROC, at 5.10X, but has higher interest coverage of 2.92, vs. 2.44X for AROC.

Debt:

AROC has no debt maturing until November 2024, when its $251M credit facility comes due. Beyond that, it has 2 Senior Notes coming due in 2027 and 2028. Mgt. has repaid over $300 million in debt since the end of 2019.

Analysts' Targets:

Wall Street analysts have seriously ramped up their price targets for AROC since October '22, by 28 to 30% for the average and low-price targets, while the highest price target jumped 36%, from $11.00 to $15.00.

Valuations:

AROC looks a lot cheaper vs. its industry's averages on a Price/CAD basis, and on a Price/Book basis. EV/EBITDA is in line with the industry average, while AROC's P/Sales is a bit higher than average.

Parting Thoughts

We rate Archrock, Inc. a BUY, based upon its secure position in its industry, its decreasing debt load, and its well-covered, secure dividend.

All tables furnished by Hidden Dividend Stocks Plus, unless otherwise noted.

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