USA Compression Partners: Oil And Gas Need Not Apply – USA Compression Partners, LP (NYSE:USAC)

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USA Compression Partners (USAC) navigates a very volatile industry by ignoring the volatile part of the business. This is necessary for the partnership to pursue its income focus. Therefore the partnership basically tells the oil and gas industry part of the business “thanks but no thanks”. That part of the business is very tightly controlled because it is cyclical. The partnership needs steady income to pursue its focus of income investors.

Other competitors such as Archrock (AROC) and CSI Compressco (CCLP) have embraced the oil and gas business far more. In fact CSI Compressco leveraged the company financially, as the oil and gas industry recovery began to increase the company’s participation in that recovery.

But that makes the competitors variable income vehicles. Their profits go up with the compression demand cycle that is part of the cyclical oil and gas industry. Unfortunately, earnings also crash with that same cycle. A partnership such as USA Compression Partners must therefore focus on compression demand that is not cyclical to support the income model.



Source: USA Compression Partners J.P. Morgan High Yield and Leveraged Finance Conference February 26, 2019 Investor Slide Presentation

Notice on the slide above the explicit limited exposure to crude oil well business. The partnership will most likely go after the business available from the majors. Exxon Mobil (XOM) and the other majors develop fields on a project basis. Rumors have long flown that the breakeven for Exxon in the Permian (for example) could be as low as $10 BOE because Exxon is integrated. That low breakeven would appeal to the partnership because the business would qualify as steady business.

Instead, there are plenty of other businesses that need compressors. Utilities that build and run gas plants would be a prime example. Another would be gas processing plants and the demand from midstream pipeline companies. In many ways, this company does not compete as much with competitors Archrock and CSI Compressco because both of these companies service the oil and gas industry.

Strategy Effects

The other parts of the compression industry generally do not grow as fast as the cyclical oil and gas industry. The growth of utilities, for example, is steady. But that growth is nowhere near the bustling pace of the current compression needs for the oil and gas industry. Plus the growth of USA Compression will slow as the partnership increases in size. On the other hand, there was a far smaller financial struggle to maintain the partnership distribution during the last compression cycle downturn.

USA Compression did need a little help to purchase the compression business from Energy Transfer Partners (which is now Energy Transfer (NYSE:ET)). Roughly 6.4 million units issued to the general partner in connection with the purchase and elimination of IDRs did not receive distributions for one quarter. That maneuver pumped up the distribution coverage ratio and in effect allowed the partnership to play the financial leverage game without publicly admitting to leverage (because the partnership used equity).

Those units will be in the distribution calculation this fiscal year. But that gave the partnership one year to expand the fleet and otherwise increase profitability to adequately cover the distribution. The oil and gas part of the business featured idled units sitting around that needed some attention before they went back into use. Oil and gas compression leasing rates are also rising. But the effect of rising leasing rates will not be as apparent for the partnership as it is for the competition.

Still the current boom in the compression business is a bonanza for the partnership. It is just that the income strategy of paying most of the cash flow to investors leaves less money available to expand the fleet to participate in that boom.

Finances

Finances are adequate. But the demands of participating in the compression recovery may limit the ability of this partnership to increase distributions for a time. Therefore significant distribution increases could be a year away.



Source: USA Compression Partners J.P. Morgan High Yield and Leveraged Finance Conference February 26, 2019 Investor Slide Presentation

The largest consideration would be the exit of Riverstone. The process of selling a large position can depress the share price for a while. Therefore the current price appreciation that is underway could continue for a while into the future.

As noted above, the latest notes were issued in slightly speculative territory (not far from an investment-grade rating). The current yield would suggest some risk also. Mitigating that risk is the current compression industry recovery that is resulting in stronger pricing and increasing demand. Should that recovery weaken or abort, both the distribution and pricing of limited partnership units could suffer.

Looking Forward

As industry conditions continue to strengthen, the yield on the partnership units should continue to decline as finances improve.



Source: Seeking Alpha Website April 17, 2019

The units have increased about 40% from the 52-week lows. One of the signs of continued industry improvement is a buy ranking put out by Stifel recently. As more buy rankings accumulate, conservative investors may want to consider moving slowly to more recession-resistant positions.

Wall Street has been known to show interest once bargains move up about 50%, and this is a prime example. Continuing price improvements should be met with more buy ranking announcements by other analysts. But if a lot of analysts favor the partnership, then the risk of principal loss rises because they tend to exit at one time.

Therefore this partnership can be held by investors recognizing the cyclical risks of such a partnership. Others more conservative will want to change to other less cyclical investments once the partnership comes back into market favor.

Finances are stronger (slightly below investment grade), and the new general partner Energy Transfer should manage this partnership conservatively. Those who can withstand the inevitable price fluctuations as market attitudes change about the compression industry (right or wrong) can make this a core holding. Additional purchases can be made when the partnership is out of favor as it clearly was towards the end of 2018. Some may want to do dollar cost averaging rather than guess when to purchase.

For now, the future looks bright with definite price appreciation potential for the limited partnership units. The distribution coverage should grow and eventually continue to exceed 20%. Then the yield shown above should decrease to 8% or less as Mr. Market perceives a much safer distribution. That would imply a conservative appreciation potential of more than 30% from the current unit price. Combine that with an attractive yield for an attractive 12- to 24-month return.

I analyze oil and gas companies and related companies like USA Compression Partners in my service, Oil & Gas Value Research, where I look for undervalued names in the oil and gas space. I break down everything you need to know about these companies — the balance sheet, competitive position and development prospects. This article is an example of what I do. But for Oil & Gas Value Research members, they get it first and they get analysis on some companies that is not published on the free site. Interested? Sign up here for a free two-week trial.

Disclosure: I am/we are long AROC CCLP. 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.

Additional disclosure: Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents and press releases to see if the company fits their own investment qualifications.



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