A 13% Yield, Industry Turnaround, And Upside Potential For This Pure-Play LP

Have you ever had to grit your teeth and “hang in there” while one of your holdings works through an industry trough? That’s where we’ve been at with USA Compression Partners LP (USAC) for the past few quarters. As US drilling declined and picked back up, USAC, the leading US pure play compression company, has seen its DCF and distribution coverage falter due to a lagging effect – new compression demand tends to lag increased drilling by a few quarters. Its price/unit also suffered.

Fortunately, USAC has a very supportive general partner, USAC Compression Holdings LLC, which has continued to reinvest 50% of its quarterly distributions in USAC. This has allowed to maintain a “cash distribution coverage ratio” above 1x. (Left column is Q2 ’17; right column is Q1 ’17):

(Source: USAC site)

Here’s how this has played out over the past four quarters – the DCF/Distribution coverage has below 1x, but due to the $ 6M-plus that has been reinvested each quarter, they’ve been able to maintain their $ .525 quarterly payout with a cash coverage ratio averaging 1.055x:

Management reaffirmed it’s 2017 guidance on the Q2 earnings release. We’ve updated this table with the actual distribution figures from Q1-Q2, to compare them to the guidance figures.

If USAC maintains the current level of total distributions, their traditional DCF/Distribution coverage will be in a range of .84x to .95x, according to the DCF guidance range.

However, if their GP continues to reinvest its distributions in Q3 and Q4 ’17, USAC’s cash distribution coverage ratio will be in a 1.06x to 1.20x range.

In this table, we compare the actual Q1-2 ’17 EBITDA and DCF figures vs. the pro-rated 2017 guidance figures. So far in 2017, management has achieved the low end of its guidance in both DCF and EBITDA.

However, there are reasons to believe that this will improve in the second half of 2017 and in 2018, which we’ll detail in the Earnings and Back To The Future sections further on in the article.

Distributions:

USAC’s next distribution should have an ex-dividend date sometime in late July. It pays in the usual Feb/May/Aug/Nov LP cycle. Management has maintained a $ .525 quarterly payout since August 2015, which is 23.53% above its targeted minimum quarterly distribution.

You can track USAC’s price and current yield in the Basic Materials section of our High Dividend Stocks By Sector Tables.

Unit holders get a K-1 at tax time.

Note: Investing in LPs and MLPs may present tax complications when done in an IRA. Additionally, since LPs usually make tax-deferred distributions, you’d reap more tax benefits by holding them in a non-IRA account. At any rate, please consult your accountant about this issue.

Options:

We feature option-selling trades for USAC in our premium subscription service, which we can’t reveal here, but you can see details for over 25 trades in our free Covered Calls and Cash Secured Puts Tables.

Earnings:

In Q2 ’17, EBITDA was down slightly vs. Q2 ’16, while DCF fell -11% due to “some acceleration in maintenance activities during the quarter, as demand for certain idle units in our fleet increased more than expected.”

OK, so DCF was down due to increased demand – not a totally negative scenario – they needed to spend to prepare more machinery for future service.

Sequentially, this was USAC’s best EBITDA figure since Q2 ’16. Fleet utilization was also up, as they noted on the Q2 earnings call: “Our average horsepower utilization for the second quarter was 91.2%, up nicely from 88.2% in Q1, continuing the upward movement of recent quarters.”

“We increased our core compression service revenues by about 5% over the first quarter and achieved a gross margin of over 67%, which was also up from the first quarter.”

Here’s what investors have had to deal with over the past 4 quarters, in return for receiving the steady $ .525/unit quarterly payout – flat revenue, EBITDA down -6%; DCF down -10%; DCF Distribution Coverage down -20%; and unit growth of 12.43%.

Like many of the companies we cover in our articles, USAC has long-term fee-based contracts. Management has also done a good job of keeping bad debt at a minimum, (less than 0.07% over the past 12 years), through partnering with larger, solid counter-parties, and maintaining long-term relationships:

We wouldn’t be braving these headwinds over the past year if it wasn’t for management’s long-term track record of growth – EBITDA CAGR of 15%, Revenue CAGR of 16%, with margins above 50%, (and, of course, the steady distribution).

In addition, USAC has a long history of weathering natural gas cycles. Due to the critical need for its compression services – producers need compression to move natural gas through the pipeline system. This company isn’t going away anytime soon:

Another factor which makes compression services “sticky” over the long term is the profile of natural gas wells in shale plays, which not only need more compression but also tend to have a long 20-year-plus life, after stabilizing.

Management has grown USAC’s asset base considerably, but also made a savvy move in 2016 and 2017 – they cut capex substantially, in response to the downturn:

(Source: USAC site)

Back To The Future:

So, can USAC return to growth, or, at least get to better distribution coverage in the second half of 2017 and in 2018? Management thinks so. On the Q2 earnings call, they said the following:

Looking back on the quarter, we experienced increased activity on the part of our midstream and large E&P customers. This increase in demand has led to tightening in availability of certain types and classes of equipment, leading to increased fleet utilization, both for USA Compression as well as select sector peers. USA’s larger horsepower fleet utilization is now back to levels virtually the same as before the industry decline, in the mid-90% area.”

We also improved visibility regarding demand for our services and corresponding contracting activities, well into 2018. Given this tightness, we have increased the monthly service fees we charge on many types of equipment we use to provide our services.” (Emphasis ours)

During the second quarter, we also saw strong contracting activity, signing new contracts for upwards of a 160,000 horsepower.”

As of the end of the second quarter, we expect to take delivery of approximately 70,000 new-build horsepower in the second half of 2017, part of approximately a 125,000 total horsepower that is already contracted and expected to start in the back half of the year, further increasing utilization as well as revenues and cash flow.”

For 2018, we’ve already contracted to build and take delivery of approximately a 150,000 horsepower throughout the year with the majority already spoken for by our core customers.”

able to see increasing cash flows and increasing activity over the next — the rest of this year and well into 2018. We think we kind of grow back into a coverage level that’s a little more attractive than where we are now.”

Another positive note was that management doesn’t see any more unit dilution in the near future: “We are not looking at any need for equity and we think that the business kind of naturally delevers over the course of the next two, four-plus quarters.” (Source-Q2 earnings call)

Industry Tailwinds:

Management also addressed the changes which have been evolving in the industry on the Q2 earnings call:

“There is a fundamental shift occurring in the oil and gas industry as certain shale plays move from the exploration/exploitation mode into the development mode, driven in many cases by our larger upstream customers. This moment toward massive mining type, manufacturing oriented project results and initial production volumes in many cases approaching those of large offshore production platforms.”

“Our business is driven by natural gas demand and production. As the industry has evolved into these larger projects, our large horsepower fleet sits right in the middle of it all. We continue to see significant activity by our customers, especially in the Permian and Delaware basins, and it is all focused on the very largest compression units in our fleet.”

(Source: USAC site)

What’s causing the increased demand for compression? US producers are adding rigs in key areas – excepting the Marcellus, which was up 73% from the trough, all of the areas listed below had rig counts up by triple digits as of 8/11/17.

(Source: USAC site)

As management noted in the earnings call, “The factors driving natural gas demand and the associated need for increased domestic natural gas infrastructure remain firmly in place – exports to Mexico, LNG exports, industrial demand, and gas-fired electric generation.”

(Source: USAC site)

Risks:

As we noted earlier, USAC isn’t currently covering its distributions in a traditional DCF/distribution model – its general partner, USAC Compression Holdings LLC, has been supporting the distribution by electing to reinvest 50% of its distributions into the company’s DRIP plan, which affords USAC more cash to continue paying out that $ .525 distribution every quarter. If the general partner decides to stop reinvesting in the near term and USAC’s anticipated earnings growth doesn’t emerge, management may be forced to cut the distribution.

Hurricane damage – Hurricane Harvey caused some wells to be shut in within the Eagle Ford area – the net downside is unknown as of yet. “The shut-in wells also have disrupted natural gas pipeline flows into Mexico, one of the biggest purchasers of Eagle Ford gas, and caused prices to spike there.” (Source: mysanantonio.com)

However, a 9/11/17 update from Forbes said that “A variety of midstream companies have provided updates on operations and the punchline is there has been very minimal damage and operations have either restarted or in process of restarting at various facilities. This is consistent for producers, with crude oil and natural gas production coming back on-line as well.” (Source:forbes.com)

Analysts’ Targets:

USAC is now 12.6% below analysts’ current $ 17.60 price target, and 28% below the $ 20.00 high price target.

Valuation:

USAC’s 13.44% yield dwarfs the Oil & Gas Equipment & Services industry’s average 1.67% yield, while its Price/Book is considerably lower.

Financials:

The industry isn’t known for high ROA and ROE figures – the amount of heavy equipment needed implies a large depreciation and amortization charge vs. net income, which makes USAC’s tiny ROA and ROE figures look good by comparison. Its Operating Margin is also much higher than broad industry averages, while its Debt/Equity level is much lower.

Debt and Liquidity:

Management commented on current leverage on the Q2 earnings call – “Outstanding borrowings under our revolving credit facility as of quarter-end were $ 725 million, resulting in a leverage ratio of 4.94 times, consistent with the first quarter and well within our covenant level of 5.5 times.”

The $ 1.1B credit facility matures in 2020. They had ~ $ 375M available as of 6/30/17.

(Note: we used trailing EBITDA to derive a 5.04x ratio, whereas management uses Q2’s EBITDA annualized vs. debt, to come up with their 4.94x figure.)

Summary:

We continue to rate USAC a long-term buy. This is a company which has weathered numerous Energy cycles, and we feel that they will do so once again. Meanwhile, income investors receive a very attractive quarterly payout.

All tables furnished by DoubleDividendStocks.com, unless otherwise noted.

Disclaimer: This article was written for informational purposes only, and isn’t intended as personal investment advice. Please practice due diligence before investing in any investment vehicle mentioned in this article.

Disclosure: I am/we are long USAC.

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.

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Gaming all-stars reflect on 30 years of a dynamic industry

The future of gaming?

The gaming industry has had an interesting 30 years.

Many of the industry’s biggest names took the stage at the Game Developer’s conference in San Francisco today to look at how technology and trends have changed the industry. Chris Crawford started the first GDC, then known as the Computer Games Developer Conference, in 1987 in his living room. He was the first to speak, showing just how far technology has come. He noted that his computer today now has 2,000 times more memory than the one he had 30 years ago. The user base for desktop PCs has gone from 100 million to billion. Consoles have gone from 62 million to 600 million. Today, we have new gaming markets like tablets and smartphones.

And gaming has become a $ 99.3 billion market.

“You guys live in a completely different universe than I did when I started this conference,” Crawford said.

Lori Ann Cole, a designer of the Quest For Glory series, talked about the history of adventure games, which involve storytelling and puzzles. It started with a 1977 game called Adventure, a simple, text-based program. The first to add graphics was 1980’s Mystery House, and it led to classic Sierra On-Line adventure series like King’s Quest and Police Quest.

He doesn't need to practice, man. He's good!

Above: We once thought Grim Fandango was the end of adventure games.

Image Credit: NeoGaf

LucasArts soon followed, making an impact with humor and cleverness in games like Monkey Island and Day of the Tentacle, until Grim Fandango was the company’s last adventure game in 1998. The industry considered the genre dead after Grim Fandango failed to generate sales. However, adventure games have found renewed life from companies like Telltale and Double Fine, whether built on brands like The Walking Dead and Game of Thrones or funded by gamers through Kickstarter.

“Adventure games are alive and well and still very fun to play,” Cole Said.

The 7th Guest creator Graeme Devine then took the stage, recalling that his first GDC was back in 1990, when MS-DOS was still the primary operating system for computers. He remembered when it used to take dozens of floppy disks to install games. The CD-ROM helped advance the industry. It gave developers the capability to add things like full sound support. It also allowed people to install encyclopedias and dictionaries on their computers. For gaming, CD-ROM resulted in massively successful games like Devine’s The 7th Guest and its competitor Myst, both of which were impossible before the CD era.

Phil Harrison, who worked at Sony from 1992 to 2008, also recalled 1990, however he remembered the intense rivalry between Sega and Nintendo. He also noted Sony’s early relationship with Nintendo that eventually broke down and resulted in the creation of the PlayStation brand. He noted that the advent of CDs made games cheaper, since they could manufacture disks for less cost than cartridges.

The PlayStation was state-of-the-art when it came to 3D graphics, with Sony spending $ 50 million on research and development on its first home gaming console. He also noted that the PlayStation name wasn’t popular with Sony in the U.S., who wanted to call it the PSX instead. Games like Wipeout and Crash Bandicoot helped to make the system the hit, and blockbusters like Tomb Raider and Final Fantasy VII helped to make the industry more mainstream. The success of that first system resulted in a brand on consoles alive today with the PlayStation 4.

Sony PlayStation

Above: Sony’s first system, the PlayStation.

Image Credit: Sony

Raph Koster, the lead designer of Ultima Online, then talked about MUDs (multiuser dungeons), the early version of multiplayer online role-playing games. These were the first virtual worlds. Ultima Online, EverQuest, and Asheron’s Call became “the big three” of MMO pioneers. Koster noted that the developers of all these games were friends. They realized that the work they were doing was different from their peers, as they had to deal with the social issues that came with making new worlds. 2004’s World of Warcraft quickly dominated the market and resulting in a floodgate of new MMOs like Star Wars: The Old Republic and Lord of the Rings Online. Koster noted that innovations in MMO resulted in gaming innovations like free-to-play, social gaming, and digital currency. He noted that open-world and virtual reality games are taking over the niche that MMOs once served of letting people live in virtual worlds.

Dave Jones recalled 21 years ago when a company he worked for called DMA began working on a top-down racing game that eventually turned into Grand Theft Auto (DMA eventually became Rockstar). It was a pioneer in the open-world genre by enabling players to get out of their cars and explore. It wasn’t just about racing. It tasked players with completing missions by hijacking cars and shooting enemies. Just 10 people made the first Grand Theft Auto.

“Open-world games are like a chemistry set,” he said. Jones explained that it’s fun to mess around with ingredients and see what you get. The success of Grand Theft Auto has resulted in dozens of open-world games, including recent hits like The Division and The Witcher III: Wild Hunt.

The Northern Kingdoms of the Witcher 3.

Above: The Northern Kingdoms of the Witcher III.

Image Credit: CD Projekt RED

Ken Lobb from Microsoft Studios then talked about digital distribution. Xbox Live Arcade started in 2003 as a way to bring arcade games to the Xbox platform, hoping to get retro games like Robotron 2004 playable on modern systems. The company added features like leaderboards and trophy support. The brand took off when it took a minigame from Project Gotham Racing, Geometry Wars, became a standalone release on Xbox Live Arcade. The brand became a hit thanks to games like Trials HD and Shadow Complex. Microsoft also launched the Summer of Arcade promotion, that gave extra exposure to the digital games. He also noted that they had an Xbox 360 version of GoldenEye almost done but lawyers shut it down.

The success of Xbox Live Arcade helped make the idea of digital-only releases more standard, and it gave independent developers a way to release games without having to worry about the expensive prospect of manufacturing physical copies.

Chelsea Howe from EA Mobile then talked about the advent of social gaming. It started with 2009’s Farm Town on Facebook, but FarmVille quickly overshadowed. Puzzle and simulation games soon helped to popularize free-to-play games. It also resulted in “dark design trends” that had players begging friends for help via Facebook posts. It turned friends into another form of currency. Social games also made live data an essential tool for game makers that wanted to see how engaged its players were (and how much money they were spending). The big boom of social games ended in 2012 after Facebook introduced more restrictions along with the rise of mobile.

The original FarmVille.

Above: The original FarmVille.

Image Credit: Zynga

Luke Muscat, designer of the mobile hit Fruit Ninja, then came onstage to talk about the mobile industry. He explained that 19,310 games were submitted to the iOS App Store in January alone, showing just how crowded the industry has become. But quality can still stand out. Modern mobile games like Crossy Roads and Clash Royale continue to become huge hits. He noted that when he originally entered the game industry and worked on traditional titles, his parents were supportive but ultimately couldn’t really relate. However, mobile games has allowed people like his parents to understand.

“Our families are not a part of this industry we love so much,” Muscat said.

Tim Schafer of Double Fine then took time to talk about the trend of crowdfunding, which he helped launch with Broken Age. He noted that money for development used to come almost exclusively from publishers, but crowdfunding has given developers a way to get the money needed to make a game directly from players. He noted that Double Fine initially resisted using Kickstarter in 2010, thinking it couldn’t work for a big game. Then, in 2012, it asked for $ 400,000 to fund an adventure game and a documentary. It ended up earning over $ 3.3 million. Double Fine was now able to make a game without worrying about a publisher canceling the project mid-production.

Schafer has now started his own crowdfunding site, Fig, which allows funders to actually invest in a game and potentially share in profits. Schafer used the platform to fund Psychonauts 2.

Psychonauts 2 is happening.

Above: Psychonauts 2 is happening thanks to crowdfunding.

Image Credit: Double Fine

Seth Killain, who has worked on fighting games for Capcom and Sony, took the stage to talk about esports, or competitive gaming. He talked about the Evo fighting game tournament, which he notes has grown every year and is the largest fighting game tournament in the world. Broadcast platforms like Twitch have helped esports grow into a massive business. He notes that the most successful competitive games have supportive developers and passionate players. These can help games grow long after launch. He believes that we can see games live beyond the first few months after launch and instead flourish for a decade.

Palmer Lucky, the founder of Oculus, brought up virtual reality, arguably the most notable emerging trend in gaming. He noted that three years ago the virtual reality market barely existed. He remarked that he is just 23 years old, and that this is only his third GDC. However, while much of the talk focused on gaming’s past, Lucky and VR represent the future of the industry.

“We don’t know how things are going to play out,” he said regarding the upcoming launch of VR devices like the Oculus Rift. He said that there will be successes, but there will also be failures. The industry will have to learn together what works in VR. He said that gaming was stuck in a rut for a while, but things like VR and esports have energized the industry.

It was pretty spectacular to see these notable figures take us on a short history of gaming, remind us how things we take for granted like digital media and open-worlds were once huge innovations that shook the industry. It also allows us to see, thanks to VR, that the innovation isn’t stopping.

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