USA Compression Partners LP

NYSE:USAC

Earnings Call Analysis

Positive Quarter with Strategic Focus

USA Compression Partners experienced significant milestones, heralding a positive quarter. Distribution coverage ascended to 1.39 times, while the leverage ratio advanced towards the goal, resting at 4.21 times, edging closer to the 4.0 target. The company's unit price rebounded impressively to over $26, levels unseen since 2014, thanks largely to strategic index inclusion and investor confidence in revenue and EBITDA stabilities. Revenues are fostered by enduring demand for compression services, propelled by global energy forecasts and burgeoning natural gas exports. Further, a forecasted shortage in large compression units, exacerbated by inflation, paves the path for heightened service fees and favorable market positioning for USA Compression. They've also maintained a disciplined investment strategy, focusing on revitalizing idle assets over purchasing new equipment at inflated prices amid current geopolitical flux. Revenue-generating horsepower saw a 1% uptick, with a flat distribution of $0.525 per unit. The company sustains a robust operational and financial trajectory, underscored by no immediate plans for equity issuance, instead opting to continue the momentum of balance sheet strengthening and leveraging industry dynamics.

Strengthening Financials and Operational Performance

USA Compression Partners reported continued improvement in their financial and operational results for the third quarter of 2023, demonstrating capital discipline and focused asset return maximization. Notably, the distribution coverage ratio increased to 1.39 times, and the leverage ratio improved to 4.21 times, progressing toward the company's goal of 4.0 times. This strategic positioning is advantageous as the company approaches the maturity of senior notes in the second and third quarters of 2026 and 2027 respectively.

Macro Environmental Support and Business Drivers

The company is supported by a macro environment conducive to its growth, with forecasts indicating a tight global crude oil market stretching into 2024. The demand for U.S. natural gas is also anticipated to reach new highs in 2023 and the following year, with fresh LNG facilities expected to boost this trend. USA Compression Partners views these factors, coupled with industry-wide capital discipline, as foundational for a robust and lasting demand for their compression services.

Optimizing Customer Base and Margins Amid Equipment Shortages

The company plans to leverage ongoing equipment shortages to refine its customer base, focusing on larger customers who appreciate high-quality compression services. This strategy is anticipated to aid in maintaining high fleet utilization rates and widening economic margins. For instance, the average revenue per horsepower per month rose to $19.10, and fleet utilization at the quarter's end reached 94%. The company is committed to adjusting its capital investment strategy as market dynamics evolve to ensure maximal stakeholder value.

Corporate Culture and Safety Commitment

USA Compression champions a strong safety culture, underpinning every aspect of its operations. This commitment to safety has led to performance that exceeds industry averages, reflecting the company's dedication to the wellbeing of employees, contractors, and customers alike. The emphasis on safety is part of the company's ethos and is continuously supported by all employees.

Sustained Revenue Growth and Adjusted Gross Margins

The third quarter of 2023 saw a notable 5% increase in sequential quarter revenues and a striking 21% increase compared to the same period in the previous year. Despite inflationary pressures on parts, supplies, and labor, the company has maintained steady margins through productivity improvements and contractual adjustments. With ongoing pricing arrangements and CPI-U rate adjustments, USA Compression anticipates sustaining adjusted gross margins around the historical average of 67%.

Earnings Call Transcript 2023-Q3

[Operator]

Good morning. Welcome to USA Compression Partners Third Quarter 2023 Earnings Conference Call. During today's call, all parties will be in listen-only mode. At the conclusion of management's prepared remarks, the call will be opened for Q&A. [Operator Instructions] This conference is being recorded today, October 31, 2023. I would now like to turn the call over to Chris Porter, Vice President, General Counsel and Secretary.

[Christopher Porter, executive]

Good morning, everyone, and thank you for joining us. This morning, we released our operational and financial results for the quarter ending September 30, 2023. You can find a copy of our earnings release as well as a recording of this call in the Investor Relations section of our website at usacompression.com.

During this call, our management will reference certain non-GAAP measures. You will find definitions and reconciliations of these non-GAAP measures to the most comparable U.S. GAAP measures in our earnings release. As a reminder, our conference call will include forward-looking statements. These statements are based on management's current beliefs and include projections and expectations regarding our future performance and other forward-looking matters. Actual results may differ materially from these statements.

Please review the risk factors included in this morning's earnings release in our other public filings. Please note that information provided on this call speaks only to management's views as of today, October 31, 2023, and may no longer be accurate at the time of a replay. I will now turn the call over to Eric Long, President and CEO of USA Compression.

[Eric Long, executive]

Thank you, Chris. Good morning, everyone, and thanks for joining our call. I am joined on the call today by Eric Scheller, our COO. This morning, we released our third quarter 2023 results, which highlight the continued improvement in our financial and operational results as we continue to focus on capital discipline and maximizing return on our assets. Eric Scheller will provide more detail on our results, but I would like to highlight our third quarter distribution coverage which grew to 1.39x, continuing our trend of increasing distribution coverage this year.

In addition, our leverage ratio was 4.21x continuing progress towards our previously mentioned goal of 4.0x. I welcome the improvement in both metrics. Methodical delevering of our balance sheet over the coming quarters positions us well for when our senior notes mature, which is not until Q2 2026 and Q3 2027.

Our unit price this past year has trended up from the $18 range to recently over $26, levels last seen in 2014. We attribute this to the recent addition of compression as a qualifying activity in the Vetify-Alarium MLP Infrastructure Index, AMZI, as well as what we believe is a show of confidence by investors in the historical stability and sustainability of USA Compression's revenues, EBITDA, DCF and distributions.

Long-term investors have seen that since we became a public company over 10 years ago in 2013, we have provided stability and growth across numerous energy, macroeconomic and interest rate cycles and have never reduced our quarterly distribution. In fact, we have proactively returned over $1.6 billion to our unitholders through distributions, reflecting a history of capital discipline that returns value to unitholders that extends well before that concept became a core focus for our industry by the investment community.

Switching gears, I would like to reaffirm some of the drivers supporting our business. As we have mentioned in the past, we believe the macro environment in our industry remains supportive for the continued improvement of our financial and operational results. The IEA and OPEC are both forecasting a very tight global crude oil market for the remainder of the year and into 2024.

OPEC recently updated its global outlook projecting continued increase in oil demand through the end of its forecast period in 2045 as rising energy demand in emerging markets offset any demand declines in the developed world. In addition to the continued need for crude oil, U.S. natural gas exports are expected to reach record levels in 2023 and continue to grow in 2024, especially as major new LNG facilities are scheduled to come on stream in the U.S. over the next few years. These factors, combined with the capital discipline seen throughout the industry, we believe, provides a solid and sustainable base for the demand of our compression services.

As we reflect more on the natural gas compression industry in particular, we continue to believe there will be an industry-wide shortage of large horsepower compression units of the type that make up the bulk of our fleet horsepower. We believe this shortage will persist for the foreseeable future as recent inflation has caused new equipment costs to reach levels that make new unit purchases economically less attractive for natural gas compression service providers.

As a result, we are experiencing a continued tightening in the compression market. Our customers and others in the industry have just begun to digest and wrap their heads around this continued tightening and inevitable substantial increases in monthly service fees required to justify the construction of new equipment due to the large increases in new equipment costs.

We believe continued equipment shortages will provide us the ability to both high grade our customer base to larger customers who understand and value the exemplary levels of compression services provided by USA Compression as well as the opportunity to capture expanded economic margins and maintain our high fleet utilization rates. We envision continued improvements to our balance sheet and financial condition, consistent with what was shown by our most recent results.

As an example, continued development of demand-driven pricing for our services increased average revenue per horsepower per month to $19.10 during the third quarter, while we also successfully increased our exit rate fleet utilization to 94%. As we have mentioned in the past, we have always endeavored to modify our capital investment strategy to maximize the value of USA Compression in response to the current market dynamics.

Given the current tightening in the natural gas compression space, the substantially higher cost of new compression units requiring dramatically higher monthly service fees to maintain our historical margins and the current geopolitical uncertainty. We believe the best way to maximize stakeholder value in the current market is to direct capital in 2024, primarily to the conversion of idle units to active status and limiting the acquisition of new organic growth compression units.

Recall that we have about 100,000 horsepower being delivered during Q4 2023 and into the first half of 2024. Acquisition costs for these units were locked in at the time of order back in late 2022 and that capital cost substantially below those now being quoted by our equipment manufacturers and fabricators for 2025 deliveries. As our customers and others in the industry digest the higher contract pricing that is required to justify the substantial increase in the cost of new compression units while maintaining our historical margins, we will continue our focus on demand-driven pricing for the compression services we provide across our existing active fleet.

As price discovery in the coming quarters for new units continues and reaches levels that support new compression unit cost, we will then, of course, reevaluate our capital investment strategy as we have always done.

Before turning the call over to Eric Scheller to discuss third quarter operating and financial results, I would like to express my unwavering support to all of our employees for embracing and living our culture of safety here at USA Compression. The safety of our employees, contractors and customers is absolutely the most important thing we do as a company. I am pleased that our safety performance is outperforming the industry average and that our employees continue to focus on being safe in all we do each and every day.

We are extremely proud of our employees and thank every USA Compression employee for their continued commitment to our safety policies and procedures. With that, I will turn the call over to Eric Scheller, our COO, to discuss our third quarter highlights.

[Eric Scheller, executive]

Thanks, Eric, and good morning all. As Eric noted, the strong results we reported this morning once again reflect our employees' continued commitment to creating value for USA Compression and its stakeholders. In addition to our increased utilization and pricing, Eric mentioned, we also continued to capture extended contract tenors for both new unit contract activity and renewal contracts for existing fleet assets.

Given the durability these extended contract tenors provide and the continued market tightness, we believe the underlying fundamentals of our business will remain supportive for the foreseeable future.

Our third quarter 2023 results revealed a 5% increase in sequential quarter revenues and a 21% increase in revenues compared to the year ago period. While revenue growth was driven by continued utilization and pricing improvements, margins remained relatively steady on a sequential quarter basis as we continue to offset our increased inflationary costs, through both productivity improvements and contractual inflation and CPI pass-through adjustments.

Although we continue to experience inflation in parts, supplies and labor, we believe the continued demand-driven pricing discovery occurring for our services, along with the CPIU rate adjustments provided before in the bulk of our customer contracts, we'll continue to support adjusted gross margins in line with our historical averages closer to 67%.

Third quarter 2023 net income was $20.9 million. Operating income was $61 million. Net cash provided by operating activities was $50.1 million, and cash interest expense net was $41.4 million. Cash interest expense increased by approximately $1.2 million on a sequential quarter basis due to higher average outstanding borrowings and higher interest rates applicable to outstanding borrowings on our floating rate credit facility. However, this increase was more than offset by $2.5 million of cash payments received under our $700 million notional principal fixed rate interest rate swap.

Turning to operational results. Our total fleet horsepower at the end of the quarter remained essentially flat for the previous quarter at approximately 3.7 million horsepower. Our revenue-generating horsepower increased by 1% on a sequential quarter basis due to a combination of converting idle units to active status as well as the addition of new large horsepower units.

Third quarter 2023 expansion capital expenditures were $62.5 million, and our maintenance capital expenditures were $7.2 million. Expansion capital spending continues to consist of reconfiguration and make ready of idle units, along with accepting delivery of 20,000 horsepower of new large horsepower units during the quarter. We currently expect to take delivery of an additional 62,500 horsepower of new large horsepower units during the fourth quarter, plus additional and ongoing conversion of current fleet idle units to active status.

During the first half of 2024, we expect to take delivery of 37,500 horsepower, which is the remainder of our late 2022 order. Additionally, throughout 2024, we anticipate the conversion from idle to active status of about 100,000 horsepower of existing fleet assets and capital costs substantially below those of new organic growth equipment builds.

Finally, I am pleased to share that on November 3, we will make our 43rd consecutive quarterly distribution payment. The $0.525 per unit distribution is flat to the previous quarter's distribution. And with that, I will turn the call back to Eric Long for concluding remarks.

[Eric Long, executive]

Thank you, Eric. Our third quarter reflects our employees' ability to continue to deliver meaningful value to our stakeholders. Given the continued tightness in crude oil markets, the increasing use of natural gas globally and the shrinking supply of available large horsepower natural gas compression domestically, we firmly believe that USA Compression is well positioned to improve our financial metrics in the future. Continued improvements to our active fleet size, utilization, contract tenors and contract pricing will increase our financial optionality for further capital investment, leverage reductions and distribution policy changes.

To conclude, we are extremely pleased with our third quarter results highlighted again by record quarterly revenues, adjusted EBITDA, distributable cash flow and distribution coverage and which also featured continued improvements to utilization and contract pricing. We expect to file our Form 10-Q with the SEC as early as this afternoon. And with that, we will open the call to questions.

[Operator]

[Operator Instructions] Our first question comes from Selman Akyol from Stifel.

[Selman Akyol, analyst]

I guess, first of all, can you just talk about lead times for new equipment? Is it still about a year out? Or is it getting longer?

[Eric Long, executive]

Selman, this is Eric. Really good question in light of the market environment we're living in. Things have actually lengthened on the delivery of major components from our largest manufacturer, Caterpillar. They've got a pretty nice order book, but they continue to have rolling supply chain issues, and it's not any one thing, is multiple things that are occurring. So we're substantially in excess of a year for orders that would be placed today.

[Selman Akyol, analyst]

Got it. And then in terms of just when you're speaking with your customers, are you seeing any changes in the tenure of contracting? Are you being able to do longer than 3 to 5 years? Or is it still sort of in that period?

[Eric Long, executive]

Yes. So I'm going to get that 2 ways. The first thing would be kind of the original primary term. We're routinely seeing 5-year contracts. We really don't go much beyond 5. We have a few instances throughout the history of the company where we see some things longer than that.

At the end of the primary term, when things do revert to a 30-day, month-to-month, either party can terminate evergreen. The only thing that changes literally would be the ability to terminate a contract. It's those renegotiated, reextended tenures that we're seeing clients are signing up these renewal contracts sooner than normal. They're extending the term for longer than normal. Historically, a 5-year primary term contract. You might see folks going with a 1- or 2- or 2- or 3-year contract extension. We're now routinely seeing kind of 2 to 5 years. So the tenure is getting longer.

All of our contracts have CPI escalators on the things we entered into today. The vast majority of even our older MSAs provide for CPI escalators. So if you think about it, we have a natural inflation hedge. You look at new builds versus repricing of our existing book, we will have substantially more uplift on repricing the existing asset book over the coming years than we will from the incremental organic growth CapEx, even if it was [indiscernible] accelerator and go back to the go-go days, deploy excess amounts of growth CapEx.

So what really is going to move our dial going forward is to continue to reprice our book. We have significantly extended our tenure. We have reduced the number of month-to-month contracts by terming up with these 5-year type terms. And I think we're setting ourselves very well up for a very durable and sustainable focus over the coming years on from the bottom left of the page to the top of the right of the page on revenue growth.

[Selman Akyol, analyst]

Yes, it sounds like a really strong outlook. Can you maybe just talk about the price increases you're seeing? And I guess I'm thinking in terms of maybe spot to where your book is or maybe what you ended up contracting over the last quarter or 2?

[Eric Scheller, executive]

Selman, it's Scheller. The book has been really strong, growing up at a pretty stout rate since we started to see the return to the market all the way back in 2022. The tightness that Eric just talked about and as people are trying to figure out how to manage the greater than 12-month deliveries is bringing people to the table. At a very regular rate people aren't letting stuff get to the end of the people are coming to our regional Vice Presidents early to discuss their position. So we continue to see the growth in the existing revenue for renewals as well as for the new units that are coming on now and into the first quarter.

[Eric Long, executive]

Selman, one other comment on that, too. We mentioned in our comments that we're seeing rate increase. We're seeing CapEx costs increase, substantial CapEx cost increase. And we're not about growth for the sake of growth. We've had some competitors in the past who were private, didn't live in the public world scrutiny, and they were willing to take a dive on gross margins and utilization and other things. And we looked at it and said, our job is to maintain a return on capital that we invest in capital that we deploy.

So we look at the contracts we entered into to source new equipment 2, 3 years ago, what those things were deployed at. We look at maintaining those margins and looking then at 2025, 2026, when equipment costs go up 30% or 40%, you've got to have a commensurate increase in your monthly service fees. So my comment of, hey, we've got -- our customers are trying to wrap their head around just what this means.

Our assets are must-run assets people can't drill, can't produce natural gas, oil production, et cetera, without compression, so when they're looking at $80 oil, $90 oil, whatever it is in excess of $30 or $40 a barrel, it's highly profitable, and you're starting to see some push up in natural gas prices. You're starting to see some LNG facilities that will be coming on stream in the next 18, 24, 36 months, exactly at a point in time where there's not a lot of available equipment and cost of the equipment are going up.

So that's why we look at it. We've always been a story of stability and growth. Right now is the time for us to focus on stability. There's a lot of uncertainty in turmoil in the world, increasing interest rates. Let's control the things that we can control. And to the extent we've got key customers who recognize the value proposition, understand the value of what we bring to the table and what's going to be required with the increase in capital cost and labor cost and inflationary pressures then we'll go ahead and methodically commit to build some incremental equipment on their behalf. To the extent that the value proposition isn't recognized or people say, "Well, the cost of the new car is all be expensive here."

What can I do as an alternative, then we'll slow that growth, and we'll continue to focus on pushing our existing asset valuations up, push the monthly service fees up as these things roll off of primary term and get repriced in excess of CPI escalator. So your commentary on it, it sounds like things are pretty good. Things are really good. And I think there's just a few of us in the industry who have this type of equipment that's necessary. There's more demand for our goods and services than there are available goods and services. So in the environment we're living in with new capital costs going through the roof, shortages of equipment, better discipline in the industry. I think it bodes well for all of us for durability and sustainability over the coming quarters and coming years.

[Selman Akyol, analyst]

Got it. And then just one last one for me, as I think about the model and SG&A uptick, and I'm pretty confident that's driven by the unit-based comp expense. But -- can you just give any thought on that? Is it -- was that just like something that occurred this quarter? Or is it due to the higher unit price? Or how maybe should we be thinking about that going forward?

[Eric Long, executive]

Yes, that was -- you hit the nail on the head. That basically was stock-based comp, and that was a quarterly aberration. And I think you'll see that on a once a year basis as things vest over time and do some things along that line.

[Operator]

[Operator Instructions] Our next question comes from [ Robert Mosca ] from Mizuho.

[Unknown Analyst]

Wondering if you could maybe expand on how you plan to go about high-grading your customer base, just what those conversations look like? And is that more of an area of focus than it had been in the past, just given the tightness of the compression that you're seeing?

[Eric Long, executive]

Yes, Robert, this is Eric. And we've been in business 25 years, and we've been through ups and down cycles and we've seen customers that we add and grow with, and we've seen customers who over time have retrenched with. With the book of business that we have in our broad geographic footprint, we have concentrations of assets with key customers in certain geographic areas. And then we have fringe geographic areas or smaller customers. And as things come off of those primary term for the type of equipment that some of our larger customers see in demand, a discussion would go like this. "Hey, you've had a machine for 3 years. Your rate is x. It's time for you to sign up a new 5-year contract at a rate of substantially higher than x." Well, we don't want to do that. We'd like to sign a 1-year contract, and we're like, well, here's kind of what the rate is, take it or leave it. And we're not being cavalier about it.

We're working with our customers. But I think observation number one, some of the smaller customers and fringe areas we are repatriating those assets to redeploy. There are certain geographic areas where you had a little bit slower activity. So when you think of the Permian and Delaware basins, which are really, really hot, the Eagle Ford remains fairly active. Then you think about North Louisiana, the Haynesville, it slowed down a little bit. You think about Appalachia. It's also slowed down a little bit. The Mid-Continent area and the Rockies are kind of steady Eddie, but again, within any particular basin, you'll see some areas where assets are underutilized and will rationalize and take a bigger machine that five smaller machines could do the job of one big machine, but if conditions have changed, maybe only need 2 or 3 intermediate-sized machines.

So we're always looking to optimize our book geographically, on a customer by customer and then kind of subsets within the region. And it's just kind of part of the customer high-grading and asset geographical high-grading, so to speak.

[Unknown Analyst]

Got it. That's all really helpful. And maybe following up on some of the earlier questions. Just wondering if you have a sense of -- and I understand that some of these compression contracts, they have the inflation escalators. But as far as the proportion of your fleet that you deem to still be below market in terms of rates. Is that still a decent chunk to work through? I know you referred to having perhaps more torque -- upside torque just from the repricing than the organic CapEx. And I was hoping you could expand on that.

[Eric Long, executive]

Yes. And I think, obviously, you're trying to fine-tune your model a little bit. I would, from a modeling perspective, just kind of focus on CPI type escalation. It's not as if we have half of our units that are 1/3 below market rate or 25% below market rate. Scheller and his team have done an excellent job over the last few years of as we've worked off primary term, terming things back up. So I would wager an estimate that not that much of our current book would be at rates that were back in the kind of middle of COVID, 3, 4 years ago, type. I think we didn't chase the market down. We maintained our pricing during that time, which is why our utilization dribbled down.

So I think commensurately with where we are in the world today, looking at kind of that 3% to 5% to 7% escalation range over the coming years. Our book is not lumpy. It's not like we bought 5 LNG tankers and deployed them all at one given point in time. We've got 4,500-some-odd assets that all of those assets have staggered initial terms, staggered primary terms. So in any given month, any given quarter, any given year, we're continually having things come off a primary term.

And then we look at the market at that point in time, we look at who the customer is, what the rates are, if there -- here's what the current rate is and what the spot rate at that point in time is. So to the extent spot rates continue to increase in excess of inflationary environments, then we'll take that into consideration over the course of the coming months and quarter and year as we reprice thing. Though I think to be conservative, look at CPI and then assume that we'll probably do a little better than CPI.

[Unknown Analyst]

Understood. And maybe just a quick last one for me. I know in your prepared remarks, you referenced just your increased valuation. And would there be any interest in perhaps seeing if there's been an equity market if you guys were to do an issuance? Or is that just -- can you get to those leverage targets just with the strength of your operational tailwinds?

[Eric Long, executive]

From USA's perspective, we're happy with where we are. We're continuing to delever the balance sheet. We look at our debt cost. Now we've done a great job of locking in our floating rate debt with some swaps, we've locked in substantially below market rates over the 2024, 2025 range to make sure that we've got certainty of pricing to match our budget estimates. I don't know, I look at it and going forward, I don't think anything materially changing. The company doesn't need to issue equity. Energy Transfer seems to be pretty happy with where they sit on things.

So from a company's perspective, I don't see any need to accelerate issuing equity that historically has had a little bit higher cost than our cost of debt or equity. And if we can continue to methodically delever to our target of 4x or drop below 4x. I don't think we need to really worry about issuing any equity in going down that trail.

[Operator]

We have no further questions in queue. This will conclude today's conference call. Thank you for your participation. You may now disconnect.