Archrock Inc

NYSE:AROC

Earnings Call Analysis

Strong Financial Performance and Strategic Acquisition

Archrock's second quarter saw net income rise to $34 million from $25 million last year, with adjusted EBITDA up 15% to $130 million. The company maintained a leverage ratio of 3.2x and increased the quarterly dividend by 6%. The acquisition of TOPS will add 580,000 horsepower of assets, expected to boost earnings per share by over 10% and cash available for dividends by at least 20% in 2025. For 2024, adjusted EBITDA is projected to reach $510-$540 million, reflecting a 17% increase. Market conditions remain robust, with fleet utilization at 95% and pricing authority intact.

Strong Financial Performance in Q2 2024

Archrock reported a solid financial performance for the second quarter of 2024, showing net income of $34 million, an increase from $25 million in the same quarter of the previous year. Adjusted EBITDA reached $130 million, marking a 15% increase year-over-year. The driving force behind this growth was effective cost management and higher pricing for their services, despite transaction-related expenses and a noncash asset impairment affecting the bottom line.

Capital Expenditures and Financial Position

The company has invested heavily in growth, with total growth capital expenditures of $62 million in Q2, bringing the year-to-date total to $140 million. The overall financial health remains robust, exiting the quarter with a long-term debt of $1.6 billion and a leverage ratio of 3.2x. Archrock aims to maintain its leverage ratio between 3x and 3.5x while increasing shareholder returns, evidenced by a quarterly dividend of $0.165 per share which is up 6% year-over-year, and a dividend coverage ratio of 2.6x.

Market Position and Utilization Rates

Archrock's fleet utilization rate reached an impressive 95% as of the end of Q2, demonstrating strong activity in a favorable market for compression services, particularly in liquid-rich plays like the Permian Basin, where about 60% of their horsepower is utilized. This high demand has allowed the company to continuously increase pricing, achieving an average revenue per horsepower of $20.85, marking the 11th consecutive quarter of sequential gains.

Strategic Acquisition of TOPS

The company has announced an acquisition of TOPS for approximately $983 million, combining $826 million in cash and newly issued shares. This acquisition aligns perfectly with Archrock's strategy to enhance its position in the contract compression market, adding 580,000 horsepower of young assets that are 95% utilized. The transaction is expected to close by the end of 2024 and is anticipated to be over 10% accretive to earnings per share and at least 20% accretive to cash available for dividends per share in 2025.

Guidance for 2024

Archrock has provided guidance for 2024, excluding the TOPS acquisition. They expect adjusted EBITDA to range between $510 million and $540 million, a 17% increase from $450 million in 2023. Capital expenditures for growth are projected to be around $190 million, unchanged from the previous year, indicating a forward-looking investment approach amidst a strong market backdrop.

Future Market Outlook

The management remains optimistic about sustained demand for compression services as natural gas production grows, particularly in light of increasing LNG export capacities and the rise in electric generation from AI and data centers. The company also noted that approximately 80% to 90% of their fleet would be eligible for pricing increases over the next 18 months, suggesting a significant potential for revenue growth as existing contracts are updated.

Earnings Call Transcript 2024-Q2

[Operator]

Good morning. Welcome to the Archrock's Second Quarter 2024 Conference Call. Your host for today's call is Megan Repine, Vice President of Investor Relations at Archrock.

I will now turn the call over to Ms. Repine. You may begin.

[Megan Repine, executive]

Thank you, JL. Hello, everyone, and thanks for joining us on today's call. With me today are Brad Childers, President and Chief Executive Officer of Archrock; and Doug Aron, Chief Financial Officer of Archrock. Yesterday, Archrock released its financial and operating results for the second quarter of 2024. If you have not received a copy, you can find the information on the company's website at www.archrock.com.

During this call, we will make forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934 based on our current beliefs and expectations as well as assumptions made by and information currently available to Archrock's management team. Although management believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be correct. Please refer to our latest filings with the SEC for a list of factors that may cause actual results to differ materially from those in the forward-looking statements made during this call.

In addition, in our discussion today we'll reference certain non-GAAP financial measures, including adjusted EBITDA, adjusted gross margin, adjusted gross margin percentage, free cash flow, free cash flow after dividend and cash available for dividend. For reconciliations of these non-GAAP financial measures to our GAAP financial result, please see yesterday's press release and our Form 8-K furnished to the SEC.

I'll now turn the call over to Brad to discuss Archrock's second quarter results and to provide an update of our business.

[D. Childers, executive]

Thank you, Megan, and good morning, everyone. Archrock's second quarter performance reflects the earnings power we built through our investment in high-quality assets, exceptional customer service and efficient execution. The long-term and year-over-year strength and durability we see in our overall performance and as reflected in our second quarter results is also supported by the affordability and abundance of U.S. natural gas, which will continue to fuel growth in its demand, use and production. And this strong performance as well as the strength and durability are both further bolstered structurally by the continued capital discipline being employed across the energy sector.

Now with that backdrop, let me start today's call with a summary of key highlights from the second quarter. Our net income of $34 million was up from $25 million in the second quarter of 2023. Adjusted EBITDA of $130 million was up 15% versus the prior year period. The increase was driven primarily by higher pricing, combined with a sharp focus on cost management, leading to strong profitability.

We maintained our sector-leading financial position, including a leverage ratio of 3.2x. We continue to deliver meaningful returns to our shareholders. Our quarterly dividend per share was up 6% compared to a year ago, all while maintaining robust dividend coverage of 2.6x for the quarter.

This was a great quarter for Archrock. Thanks to a fantastic team of dedicated employees who work hard every day to deliver safe and excellent service to our customers and attractive returns to our shareholders. And now with the acquisition of TOPS that we announced last week, we will further enhance our position as the premier contract compression services company in the U.S., and I'll expand on that in a bit.

Turning to Archrock operations. Market conditions for compression remain highly constructive predominantly in oil plays with associated gas production like the Permian Basin. The robust market is reflected in our Q2 contract operation's operating and financial results.

Our fleet remained fully utilized with utilization exiting the quarter at a rate of 95%. Booking activity increased sequentially as we continued to build an order book into 2025. We expect to see sustained compression booking demand well into the future as our customers plan for the call on natural gas production to support LNG export capacity growth and incremental electric generation demand from AI and data centers.

On pricing, with utilization at historic highs and continued strong booking activity, we're maintaining the pricing prerogative and capturing additional rate increments. The second quarter marks our 11th consecutive quarter of sequential increases in our monthly revenue per horsepower, which increased to $20.85. Continued price increases and strong cost control drove adjusted gross margin percentage to 65%, up 300 basis points year-over-year and consistent with the prior quarter.

The aftermarket service segment had another solid quarter. Revenues totaling $45 million remained elevated as great service is driving repeat business with customers. Second quarter adjusted gross margin of 22% exceeded our full year guidance expectation as we continued to focus on high-quality and high-margin work. From our first rate customer base to our highly standardized fleet and excellent customer service we are known for in the field, to our most recent digitization and emission reduction efforts, the actions we've taken to enhance our business should benefit our performance for years to come.

The acquisition of TOPS aligns with this strategic focus and is an exceptional opportunity to expand our contract compression operations, earnings and cash available for dividend. With TOPS, we're adding 580,000 horsepower of young assets, including approximately 500,000 operating horsepower and a substantial and contracted backlog of new equipment.

As we previously discussed, this strategic and immediately accretive acquisition carries 4 main benefits. First, the acquisition of highly -- of high-quality assets with contracted cash flows has meaningful low-risk growth. The TOPS fleet has an average age of 3 years, is 95% utilized and backed by fee-based contracts with blue-chip customers. Second, the acquisition enhances our scale and complements our existing Permian Basin compression capacity. The addition of TOPS is expected to increase Archrock's Permian Basin compression capacity by 30% to approximately 2.2 million operating horsepower.

Third, this acquisition accelerates the growth of our electric motor drive fleet and augments our internal electrical expertise. TOPS is the leading provider of electric motor drive compression. With this acquisition, we expect our electric compression fleet to increase to 648,000 horsepower or 15% of our pro forma fleet. And fourth, this transaction is consistent with our financial and capital allocation priorities, and we expect it will facilitate the accelerated return of capital to shareholders.

We're buying a rapidly growing business with a substantial and contracted backlog. And we expect the acquisition to be more than 10% accretive to earnings per share and at least 20% accretive to cash available for dividend per share in 2025. TOPS has both high-caliber equipment and a talented team that we're excited to welcome at Archrock. The transaction is expected to close by the end of 2024, and we're confident in our ability to effectively integrate the acquired assets into our existing business.

In summary, with today's robust market of growing natural gas production and compression demand, one of our top priorities has been investing in high-quality and high-return compression assets. And equally as important, we've been funding these investments within our cash flow so that we've been able to deliver on our commitments to increasing cash returns to investors while maintaining a strong balance sheet. The acquisition of TOPS aligns with this strategic focus and is an exciting milestone for Archrock that builds on the meaningful progress we've made orienting our business for the future and for long-term success.

With that, I'd like to turn the call over to Doug for a review of our second quarter performance, 2024 stand-alone guidance and financing strategy for the TOPS acquisition.

[Douglas Aron, executive]

Thanks, Brad, and good morning, everyone. Archrock delivered another strong quarter of financial results. Net income for the second quarter of 2024 was $34 million. This included a noncash $4.4 million long-lived and other asset impairment, as well as transaction-related expenses of approximately $1.8 million.

We reported adjusted EBITDA of $130 million for the second quarter 2024. Underlying business performance was strong in the second quarter as we delivered higher total adjusted gross margin on a sequential basis. For the second quarter, growth capital expenditures totaled $62 million, bringing year-to-date growth CapEx to $140 million. We expect our 2024 growth capital will be first half weighted. Maintenance and other CapEx for the second quarter of 2024 was $29 million, bringing the total for the first half of 2024 to $51 million.

Turning to the balance sheet. We exited the quarter with long-term debt of $1.6 billion. Our leverage ratio at the end of the quarter was 3.2x calculated as total debt divided by our trailing 12-month adjusted EBITDA. As Brad mentioned earlier, we are acquiring TOPS for total consideration of $983 million, which will be funded with a combination of $826 million in cash and 6.87 million newly issued common Archrock shares to the seller.

Archrock intends to fund the $826 million cash portion of the total consideration with a combination of equity and debt. On the equity portion, last week, we announced the pricing of a common stock offering, raising net proceeds of $256 million at an offering price of $21 per share. The funding structure keeps us on track to achieve our financial targets, including maintaining a consistent leverage ratio of between 3x and 3.5x.

Post transaction announcement and equity raise, all 3 rating agencies reaffirmed their Archrock credit ratings and outlook. The strong financial flexibility I just described continued to support increased capital returns to our shareholders. We recently declared a second quarter dividend of $0.165 per share or $0.66 on an annualized basis. This is consistent with the first quarter of 2024 dividend level and up 6% versus the year ago period.

Cash available for dividend for the second quarter of 2024 totaled $72 million, leading to an impressive quarterly dividend coverage of 2.6x. Importantly, we believe the increase in pro forma discretionary cash flow from the addition of TOPS will further enhance our financial flexibility and capacity to increase dividends to our shareholders over time.

As you saw in our earnings release issued yesterday, Archrock reaffirmed its full year 2024 annual EBITDA and capital expenditure guidance. Our guidance excludes the pending acquisition of TOPS. We plan to announce our expectations for the combined company once the transaction closes by the end of 2024.

Excluding TOPS, our 2024 adjusted EBITDA is expected to range from $510 million to $540 million, which represents an increase of 17%, compared to $450 million in 2023. 2024 growth CapEx is expected to total approximately $190 million. This is flat compared to the growth CapEx of $190 million in 2023. Our full year '24 maintenance CapEx forecast of $80 million to $85 million and other CapEx forecast of $20 million to $25 million both remain unchanged.

In closing, the market remains as strong as we've ever seen it, and Archrock is in the strongest position in the company's 70-year history. We have an opportunities rich market and expect to invest in high return opportunities, profitably grow our business, while prioritizing and growing shareholder returns and maintaining an industry-leading balance sheet.

We are excited to welcome the TOPS team, and we look forward to building an even stronger Archrock together for the benefit of our employees, our customers and our investors.

JL, with that, we are now ready to open the line for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Jim Rollyson of Raymond James.

[James Rollyson, analyst]

Brad, so year-to-date, you've obviously spent well more than half of your growth CapEx, which implies a softer second half on that front. But just curious, your horsepower totals haven't moved that much in the active category so far. Just maybe -- and I know you've also realized some proceeds from selling some stuff still. But maybe just a little color on kind of fleet dynamics, like how much horsepower you've delivered? How much has been put in the field? How much have you sold? Just kind of some color on that, if you don't mind.

[D. Childers, executive]

On the overall position of the horsepower in the business, we're super excited to just maintain the 95% utilization rate that we've achieved. One of the impacts of that, as you can imagine, it does mean that we've put to work a ton of the idle fleet horsepower that we previously had, maintaining it at a high rate. And that also means there's less horsepower in the fleet to go back to work. So the trade-off is, we get to book less of that, but it's because it's active working and highly profitable. So that's one dynamic that you're seeing on the relatively flat horsepower quarter-over-quarter.

The second thing we'll note is that the market has definitely cooled a bit as we've seen a little bit of give back in some of the dry gas plays. Fortunately, as you can see in the numbers, it's completely immaterial to our overall fleet position as the vast bulk of our horsepower is going to work in the liquid-rich place, 60% of it is to work in the Permian on a bookings basis right now.

So those are a couple of the dynamics we've seen in what I think is a relatively flat period of time. But finally, on a really good news front, bookings has continued to remain robust. And so even though the horsepower activity itself is a little bit flattish for us in this current period, what 2025 offers is still a very robust bookings set from our customers as they prepare for future natural gas production growth starting in 2025 as LNG projects come online. That's a lot of what you're seeing. And then finally I'll point out that actually you're right, the CapEx budget for the year 2024 was definitely front-end loaded.

[James Rollyson, analyst]

Yes. I appreciate that color. And just kind of -- since you brought up the newbuild part of that equation or new orders, just maybe kind of a status update on what lead times look like today. And another thing that's been helping in addition to the tight market and dry pricing is just the fact that the cost of equipment has gone up. And maybe just some color on kind of what inflation has been there. Is that starting to level off, et cetera?

[D. Childers, executive]

Factually, on the easy stuff, lead times are in the 40 weeks, plus or minus depending upon the category of equipment. But we would describe it as a very normalized market. Inflation has returned to more historic levels, and that is for equipment coming into the system in the 3% or 5% range on a per annum increase basis. That's our expectation. It's what we're seeing and it's our expectation.

So that's the easy stuff to point out. But what we also see then is just robust bookings continuing going forward with that. What's exciting about the market today, though, is that it's not about lead times that's constraining the market. Equipment costs are definitely up, and that means the price of bets has gotten bigger and further reinforced a lot of discipline in the market.

Capital still remains at elevated levels, so that cost has enforced discipline in the market. But what all of this goes to is -- the thing we think is really driving a lot of discipline in the market is the investors' demand and focus on free cash flow generation, strong balance sheets and continued growth in returns to investors. That level of discipline means that no one is going to borrow expensive money to place expensive bets without the security of a commitment and a booking, with a contract in place with a customer already. That's what's really driving the market. We think it's about capital discipline. We don't think it's about supply chain constraints.

[Operator]

Your next question comes from the line of Steve Ferazani of Sidoti.

[Steve Ferazani, analyst]

I appreciate all the detail on the call. Obviously, impressive continued growth on the revenue per horsepower. Just trying to get a sense now, are we getting closer to spot? Is there still a lot of room to go as you reset pricing on previous contracts and with the new capacity coming online?

[Douglas Aron, executive]

At these levels of high utilization, we still believe we have pricing prerogative. Spot pricing remains elevated compared to where the entire fleet is, and we will continue to opportunistically bring the fleet up to market pricing as our contracts permit us to do so over time.

And on the good news front, when we evaluate our ability to either increase pricing because the contract is eligible for it because it has a renegotiation in it or it has an automatic price increase in it or we have the ability to drive pricing under the contract terms, we estimate that over the next 18 months, we'll still be able to increase pricing on -- will be eligible to increase pricing on 80% to 90% of the horsepower in the fleet. So over time, we expect to continue to work on bringing that gap -- narrowing that gap.

[Steve Ferazani, analyst]

Excellent. You talked about -- you have less idle capacity to bring back. The only number that surprised me in the quarter was the higher maintenance CapEx. Yet your guidance didn't change, which implies this is by far the highest quarter. Usually, that's because of higher make-ready. Is that what happened? Did you just happen to have more idle capacity coming back this quarter? Or was there something else in that higher maintenance CapEx?

[Douglas Aron, executive]

No, Steve, I definitely would not read anything into that. I think we had some parts expense, some timing in the quarter. Some of that can vary just depending on when the work gets done. So as you said, we think our current guidance is absolutely good and I wouldn't read into anything beyond that.

[Steve Ferazani, analyst]

Okay. That's helpful. And last one for me just on the continued strength with the aftermarket business. Is this a new reasonable run rate for your aftermarket? And can you maintain these above 20% margins? What's your outlook? Any changes?

[D. Childers, executive]

With the market as tight as it is, not just in contract operations, but also in the fleets of our customers, our customers are very focused on maintaining their horsepower, candidly, better than they have in the past. There's less idle capacity. And so that's driving a lot of really good service activity, which is higher margin and higher profit work to Archrock. And our team is doing an excellent job both capturing it and executing on it. So I believe that as the market remains at these elevated levels of utilization that translates into strength and continued profitability both on the revenue line as well as in the profit we can obtain in our aftermarket service business.

[Operator]

Your next question comes from the line of Selman Akyol of Stifel.

[Selman Akyol, analyst]

I wanted to follow up on a couple of comments. In your prepared remarks, I think you talked about the market has cooled, some give back in dry gas plays and you're repositioning those assets into liquid plays. Can you maybe quantify how long that takes and how much horsepower are we looking at? And should we see some sort of bump from redeploying those assets in the third or fourth quarter?

[D. Childers, executive]

We should not expect to see a bump. You should not expect to see any real impact to the redeployment of those assets. What I was suggesting, however, is that with the small amount of horsepower in the dry gas plays that was reduced in the quarter -- and we're talking about a fractional percentage of our fleet -- it still has an impact in marginal growth in a period of time when equipment is not going back to work as aggressively in 2024 as it did in 2023. So I don't think you should expect to see any negative impact on that at all other than that equipment will go back to work probably in some of the dry gas plays, some of it will be redeployed elsewhere over time. But it's so marginal that it will not be transparent from a financial perspective or from a cost perspective is what I really should say.

[Selman Akyol, analyst]

Understood. And then just following up sort of on the last question in terms of about getting closer to spot. I think you said over the next 18 months, you get price increases on 80% to 90% of the eligible fleet. And I was wondering if I could push you and just ask how much of the fleet is eligible over the next 18 months to be repriced?

[D. Childers, executive]

That was the number. Between 80% and 90% of the fleet should be eligible for repricing in that period of time.

[Operator]

There are no more questions. Now I'd like to turn the call back over to Mr. Childers for final remarks.

[D. Childers, executive]

Great. Thank you, everyone, for participating in our Q2 review call. Archrock's underlying business performance is outstanding, and we're excited about the TOPS scale, which we believe will create substantial shareholder value. I look forward to updating you on our progress in the future. Thanks, everyone.

[Operator]

This concludes today's conference call. You may now disconnect.