Oil and gas infrastructure specialist Archrock (NYSE:AROC) and its former subsidiary Archrock Partners were once a textbook case of an overaggressive business that got rocked by crashing oil and gas prices. The company bet heavily on the need for compression horsepower to force oil and gas from wells to pipelines, and took on considerable leverage to do so. When demand dried up from lower production volumes, Archrock was stuck with a fleet of inactive compression equipment and a massive debt load.
Thanks to a rebound in commodity prices and a restructuring to get rid of the parent/public subsidiary corporate structure, the company is starting to show signs of life. So let's look at the company's most recent earnings report and see whether Archrock has made enough progress to be considered an investment today.
Archrock: By the numbers
|Metric||Q2 2018||Q1 2018||Q2 2017|
|Revenue||$226.9 million||$212.0 million||$197.9 million|
|Adjusted EBITDA||$84.7 million||$78.7 million||$74.1 million|
|Net income (loss)||$1.9 million||($3.8 million)||($6.68 million)|
This was the first quarter since 2015 that Archrock was able to post a positive net income result (not including the one-time tax adjustment gain at the end of last year). The gain wasn't large by any means. But it showed the slow and steady progress that Archrock has made signing up customers for well and pipeline compression services as well as servicing aftermarket sales. In the quarter, contract operations and aftermarket services revenue increased 9.2% and 30%, respectively, while gross margins for both segments remained the same at 59% for contracts and 17% for services.
In the first quarter, management noted that it was increasing its capital spending rate for the year in order to increase its fleet of available horsepower. While total available horsepower did tick up in the quarter, its fleet utilization rate remained rather healthy at 86%.
Management has said in its conference calls and investor presentations that its core goals right now are to expand its horsepower fleet to satisfy growing demand and to lower its debt leverage. Achieving these two goals simultaneously isn't exactly easy, since they both require cash. But so far, Archrock has been able to do that. It added a modest 40,000 horsepower this past quarter, and its debt-to-EBITDA ratio declined to 5.6 times for the quarter (management says it's 4.9 times, but it reports on adjusted EBITDA).
In fact, the progress it has made on these two fronts has been enough that Archrock was able to increase its dividend by 10%. While Archrock no longer has a master limited partnership subsidiary, it still reports its dividend similar to MLPs with a dividend coverage ratio. For the quarter, Archrock's dividend coverage ratio was 2.76 times.
What management had to say
On the company's conference call, CEO Brad Childers highlighted management's plans to keep raising its dividend and how it will be able to do so while also reducing its leverage:
Looking forward, we reiterate our expectation to increase our dividend by 10% to 15% annually through the year 2020. Earlier, I highlighted the recent completion of our merger transaction with Archrock Partners. The completion of this transaction reflects our company's ability to remain nimble and proactive as we strive to maximize long-term value for our stockholders.
This transaction is aligned with our capital policy in two ways. First, the transaction simplified our corporate structure and structurally lowered our cost of capital, resulting in improved returns for our capital investments. Second, the transaction was deleveraging for our company, and it accelerated the progress toward our goal of achieving leverage below 4 times in 2020.
It appears that pretty much all of its leverage reduction in the coming years will come from growing its EBITDA rather than actually paying down debt. That can work as long as demand for compression remains high, which means that natural gas demand will be high. According to Childers, that won't be too much of an issue because natural gas production is going to grow significantly in the coming quarters:
The [U.S. Energy Information Administration] is forecasting an annual increase of 10% in 2018. Producers are focused on developing the United States' vast natural resources. The increasing amount of the natural gas produced in the U.S. is associated with crude oil production. Archrock has an extensive presence in place driven by associated gas, including the Permian, SCOOP/STACK, the Eagle Ford, the Bakken, and the Niobrara.
What is most surprising is that all of the shale basins he mentioned here are known for oil production rather than gas. However, just about every oil well has some percentage of its production in natural gas. It would appear that management thinks oil producers will look to monetize this ancillary revenue stream.
You can read a full transcript of Archrock's conference call here.
Slow steps forward
I think it's pretty clear that Archrock's decision to acquire its subsidiary was the right one, even though it wasn't well received by the market on the day of the announcement. Doing so has certainly simplified its corporate structure and is helping it to tackle debt issues. There are also a lot of very favorable industry tailwinds benefiting the company, which should enable it to meet its goals of growing its dividend and reducing its debt leverage over the next couple of years.
All of the things that Archrock accomplished this past quarter were signs that the business is on the right track. Revenue and earnings growth is a litttle slower than expected, but increased investments in pipelines and other oil and gas infrastructure are going to lead to greater demand. Personally, I would like to see some more progress on its debt reduction before making an investment decision, but at least Archrock appears headed in the right direction.