Approximately six months ago, I wrote an article highlighting my opinion that USAC offered the safest 12% yield in the stock market today. Several readers of the article have since reached out to me, asking my opinion regarding USAC, and I have exchanged multiple emails with those readers. Several of them asked that I update my thoughts on USAC, and now that USAC has declared (on Oct. 17, 2019) yet another 52.5-cent quarterly distribution, I will hereby oblige those readers who have requested an update.
At the risk of revealing the punchline upfront, I conclude (as the title suggests) that USAC continues to offer the safest 12% yield in the stock market today. However, the risks I cited six months ago also remain. Also, the title may be a bit misleading inasmuch as I haven’t actually studied all 10,000+ equities available for purchase in today’s stock market. Nevertheless, based on having traded stocks for over 40 years and having studied close to 100 equities in the past year-from Apple to GE, from Tesla to Facebook and Verizon-I do believe that the title to this article is supported by the facts.
Thinking About Safety – Risk Versus Reward
Before I discuss why I think USAC offers such a compelling risk-reward proposition, let me explain how I think about risk and reward. To begin with, I think that any rational investor (and I will grant you that much investing is not rational) must balance risk versus reward when making an investment decision. Some investors (perhaps a retiree dependent on monthly investment income) are much less risk-tolerant than other investors (perhaps a younger investor with enough discretionary income such that she can take more risk). But I think we can all agree that the holy grail of investing is to find a low-risk investment that also offers an outsized return. These companies are few and far between, but they do exist.
I believe that USAC is the best one of the lot based on my step-wise analysis below.
Step 1 – What Business Is USAC In?
My first step in evaluating any company’s potential risks and rewards is to understand the business it is in. Since this article is being addressed to a wide investor audience-many of whom may not be familiar with natural gas transport around the US-I will provide a bit of background that will help the reader understand USAC’s very straightforward business.
If you heat your home with natural gas (NG)-as many Americans do-you may have wondered how the NG gets to your house. Obviously, NG is obtained from underground reservoirs that are often quite far from the population and industrial centers where the NG is used, and in the US, NG normally makes that trip in underground pipelines. But if you put NG in a pipeline in, say, the Permian Basin in West Texas (now the largest oil-producing region in the US), the NG will just sit there. If you want to get it to say, Houston, TX, 500 miles away, you have to push the NG down the pipeline-and that is, in essence, what USAC does.
Simply put, the bulk of USAC’s revenues comes from providing “compression services” to various companies that want to push their NG through pipelines from one place to another. A small part (about 15%) of USAC’s business -called “gas-lift”–involves using USAC’s compressors to assist with the maximization of oil production out of oil wells.
Step 2 – Is This a Good Business to Be In?
Now that we know what USAC does for a living, my second step in evaluating USAC is to determine the demand/supply balance for the kinds of services that USAC provides. This is important both to evaluate (A) downside risk (i.e., a decrease in demand for USAC’s services may endanger payment of its large distribution and may lower the stock’s price) as well as (B) the potential for upside growth. In USAC’s case, the nature of the compression business virtually assures minimal downside risk while providing some upside potential.
As the table below shows, NG production has risen tremendously in the US over the past few years, and everyone agrees that NG production will continue increasing in 2019 and 2020. This increasing production of NG is obviously bad news for companies that produce NG but actually, low prices of NG help sustain demand for NG (especially in coal-to-gas switching in powerplants that produce electricity).
Many experts believe that NG production will continue increasing beyond 2050, although my own projection is that NG production will begin to plateau-at a higher level than today’s production level-in the early 2030’s.
The Energy Information Administration (EIA) – the source of the above graph and of extensive data on energy in the US and abroad – states that domestic NG production averaged 83 BCF (billion cubic feet) per day in 2018, and EIA projects that NG production will average 90 BCF/day in 2019 and 92 BCF/day in 2020 (an 11% increase in US NG production between 2018 and 2020).
Note that the 2 BCF/day growth in NG production expected between 2019 and 2020 is a marked deceleration from the torrid (and unsustainable) growth rate of the past two years. Indeed, were it not for one factor (see next paragraph), one would expect there to be no growth at all in NG production until NG prices recover to at least the upper $2-range from its recent (and current) pricing in the low $2 range.
That “one factor” cited above is called “associated gas,” which refers to gas that gets produced as a “byproduct” of crude oil production. Different hydrocarbon fields (often called “plays”) almost always contain both oil and NG but because oil is somewhat better priced these days than NG (marginally so, many would argue), most companies prefer drilling for oil rather than NG. However, even while the objective may be to produce crude oil, NG often comes out of the well at the same time. Some of that gas is “flared” – burned at the wellhead – but that practice is attracting increasing scrutiny. In addition, the recent placement-in-service of two major NG pipelines out of the Permian basin down to the Gulf Coast has finally made it more economical (in many cases) to ship the gas rather than flare it. Again, while that additional NG production may not be helpful to NG producers, it is a positive for the compression companies that are hired to move that gas in the new pipelines.
Regardless of how, why or where it is produced, NG has to be compressed in order to move it from producing areas to consuming areas (in fact, depending on the length of the trip, the same NG may have to be compressed multiple times). Given that it is extremely likely that NG production will continue to increase over the next 10-15 years, it is essentially guaranteed that the demand for NG compression services will go up over the next 10-15 years.
The reader might wonder why NG production (and of course, use) has been increasing so rapidly-and why it is expected to continue to do so. To answer this question, one must look at the demand centers for NG, which are listed in the following table (2019 and 2020 amounts are as projected by EIA):
2017 2018 2019 2020
Electric Power Sector
Source: EIA October, 2019 Short-term Outlook. Short-Term Energy Outlook
As can be seen from the above table, consumption in the US will increase about 2 BCF/d in 2019 (82 to 84 BCF/d), and by 1 BCF/d in 2020 (to 85 BCF/day).
But what is not included in the table above is the tremendous increase in NG exports from (A) the US to Mexico (mostly by pipeline) and (B) from the US globally (via LNG). LNG stands for “liquefied natural gas” and the EIA graphic below shows that LNG exports from the US will quadruple in two years – from 2 BCF/day in 2018 to 5.8 BCF/day in 2019, and then to 8.2 BCF/day in 2020. So whereas domestic NG consumption will increase by 2 billion cubic feet per day from 2018 to 2020 (from 82 to 84 BCF/day), NG exports will increase by 6 BCF per day (from 2 BCF/day in 2018 to 8.2 BCF/day in 2020).
But regardless of whether NG is being consumed domestically or being exported, it has to be moved down pipelines-and that requires compression.
In summary, NG production is projected to increase going forward and that increase in production will increase demand for compression services.
Further downside protection for USAC unitholders is provided by the sources of consumption for NG. The “residential” consumption is generally pretty steady because people are unlikely to change their home-heating practices very much, although it can vary a bit from year to year, of course, depending on the weather. As can be seen from the table above, both “commercial” and “industrial” consumption are projected to increase a bit each year because generally, as GDP (gross domestic product), increases 2-3% every year, industrial and commercial activities also increase to a similar extent. Although a recession can certainly decrease commercial activity (and can therefore decrease NG demand), those decreases are generally very mild and transitory.
But the “electric power” sector is the most interesting demand center for NG, both because it is the largest demand center for NG and because it is the demand center that will increase the most between 2017 and 2020 (from 25 to 30 BCF/day, a 20% increase over a period of 3 years). There are several reasons for this, including replacing coal-fired power-generation plants with NG and the fact that many nuclear plants are reaching the end of their design lives and are often retired because they are too expensive to upgrade or replace.
Adding further to the downside protection provided by USAC is a consideration that rarely garners investor attention-but should. Many people lump NG compression services along with general “oil services” but that is a big mistake. Let me explain why. Let’s say you own a company that provides sand for “fracking” wells (the process by which sand and fluids are pumped into a shale well in order to unlock more oil). If oil prices are good, you might be very busy because your customers are fracking more wells and therefore they need more of your frac sand. But if oil prices crater, the E & P (exploration and production) companies that explore and produce oil and NG are going to curtail their drilling (and fracking) programs-as is happening right now-and your company won’t be so busy anymore because the demand for your fracking sand decreases if oil exploration and production decreases. Generally, if you fracked 100 wells last year when oil prices were good, you don’t go back to frack those same wells this year, when oil prices are not as good.
But, in significant contrast, compression services are needed not only for the gas that is being produced from the wells being drilled right now-compression is also needed for the gas that is flowing from the wells drilled last year, and the year before. Obviously, all of that gas needs to be compressed in order to move it down the pipelines-regardless of when the well was drilled. To use real numbers, in 2018, 83 BCF of NG had to be compressed to be shipped along pipelines every day, whereas this year, 90 BCF will need to be compressed-regardless of whether that gas came from a well drilled in 2018 or 2019. Therefore, in contrast to many “oil services” companies whose fortunes may rise and fall with the rise and fall of drilling activity, USAC’s revenue is not likely to drop anytime soon because as more overall gas is being moved around the US, more compression services are needed.
In summary, there is universal agreement among all stakeholders that NG production in the US will continue to increase over the next decade (many experts-myself not included-think NG production will continue to increase til 2050 and beyond), and that therefore, demand for compression services must increase over the next decade as well. This fact offers substantial downside protection for a well-run “compression services” company.
Step 3 – Is USAC A Good Choice For An Investment in The “Compression Services” Space?
Once I have determined that the business of my target company is well-protected from downside risk and also offers some upside potential, I next move to study the company itself.
Although USAC went public in January, 2013, it has been providing compression services as a private company since 1998. Its management team is experienced and has a very good reputation. USAC is constituted as an MLP (master limited partnership) which presents both advantages and disadvantages. One of the advantages is that MLP’s often pay high-to-sky-high distributions (4% to over 10%) because unlike C corporations, MLP’s are not income-taxed at the company level. USAC is at the extreme high end of that high dividend (more accurately called “distributions”) range, yielding over 12% based on its most recent (10/17/19) closing price of $17.36.
I strongly prefer investing in dividend-paying companies for a couple of reasons. First, the fact that a company pays dividends offers downside protection because as the stock price goes down, the yield goes up, which tends to decrease the amount of downside exposure.
Second, perhaps for the reason just discussed, studies have shown that as a general rule, dividend-paying companies offer better long-term returns than non-dividend-payers.
But the foregoing is only true if the dividend does not get cut, which is a very important IF. And nine out of ten times, if a company offers a double-digit yield, that is a sign of distress, a sign that the company is unlikely to keep paying its high dividend. As we study USAC’s financial and distribution-paying performance, I believe you will conclude, as I have, that USAC’s 12% distribution ($2.10/unit/year, paid at a quarterly rate of $0.525/unit) is very safe (note that MLP “shares” are not called “shares” but rather are called “units,” and if you buy some, you will be a “unitholder” rather than a shareholder).
Step 4 – USAC’s Distribution-Paying History
When I study a potential investment in a distribution (or dividend)-paying company, the very first question I ask is, “How likely is the company to continue paying that distribution?” I need to be 98% convinced (nothing in life is 100%, and most definitely nothing in the stock market is 100%) that the distribution is safe because I know that if the distribution gets cut, not only will my yield be cut but the share price will also drop significantly, causing a double-whammy to my stock account.
As a first point-and unlike many other MLP’s – USAC has never cut its distribution. Indeed, in its short life as a public company-as can be seen from the table below – USAC has increased its distribution eight times. Its first quarterly distribution after going public in 2013 was 34.8 cents. Over the next 5 quarters, USAC increased its distribution to 44, 46, 48, 49 and 50 cents, respectively. The next 4 quarters went to 50.5, 51, 51.5 and 52.5 cents, respectively, and beginning in August, 2015, USAC has declared and paid 16 distributions of 52.5 cents, with the 17th distribution of 52.5 cents coming in less than three weeks.
Total dividends in 2019:
Total dividends in 2018:
Total dividends in 2017:
Total dividends in 2016:
Total dividends in 2015:
Total dividends in 2014:
Total dividends in 2013:
Source: USAC website. Distributions & Splits | USA Compression Partners, LP
The foregoing distribution-paying track record is especially impressive given that the oil and gas industry went through major contraction in late 2014 through early 2016, with oil bottoming out below $30/barrel and NG bottoming out around $1.66/mmbtu in early 2016 (these prices are about one half and two thirds of what oil and gas sell for today, respectively). Many energy-related MLP’s cut their distributions between 2015 and 2017, but USAC did not. Demonstrating its nimbleness in the face of highly adverse market conditions, USAC was able to ride out the storm and maintain its $2.10 distribution in 2016 by slashing its capital expenditures from $285 million in 2015 to $49 million in 2016. As oil and gas prices (and the industry overall) recovered in 2017, USAC’s capital expenditures nearly tripled from $49 million in 2016 to $130 million in 2017.
Considering that USAC was laser-focused on maintaining its distribution in the face of a very challenging commodity price environment in 2015 and 2016, it seems extremely likely that USAC will continue to pay its annual distribution of $2.10/unit in the current (and future) much-more-positive macro environment.
USAC’s management has made it clear that paying the annual $2.10 distribution is a top priority for the company, and the current macro environment should make it easy for USAC to continue to do so. Eric Long, USAC’s CEO, expressed the commitment to keep paying the $2.10 distribution in the 2/19/19 conference call this way:
When USA Compression went public in January of 2013, we believe that we had a differentiated business model, one that produced stable results and attractive margins. Since that time, we have never cut our distribution. We are proud of that fact, and believe our results have validated how we viewed the business at the time of the IPO. Our large-horsepower, infrastructure-focused, demand-driven business model provides for longterm stability across commodity price cycles and has allowed us to maintain our distribution since the IPO.
In the 8/6/19 (most recent) earnings call, Long put it this way (emphasis is mine):
In July, we announced a cash distribution to our unitholders at $0.525 per LP common unit consistent with the previous quarter which resulted in coverage of 1.14x, in line with Q1. This distribution is USA Compression’s 26th distribution since our IPO in January 2013 and every [quarterly distribution] has been at a consistent or increased level from the previous quarter. Including the distribution being paid Friday, we have now returned over $780 million in distribution value to our common unitholders since going public.
In summary, although there are no guarantees in life-and certainly none in the stock market-barring some black-swan calamity, the evidence is overwhelming that USAC’s $2.10 annual distribution is very likely to continue to be paid in the foreseeable future.
Step 5 – Other Than USAC’s Excellent Distribution-Paying History, Does This Company Offer Any Other Advantages Compared to Other Companies That Pay High Dividends?
As the reader has noticed, I gave the distribution-paying history its own step, and that step came before a more detailed financial analysis of USAC. There are two reasons for this:
- When a company is paying a huge 12% distribution, the distribution will constitute a very significant portion of the expected overall return. If that distribution is not secure, the rest of the company’s financials don’t matter.
- As noted above, companies that pay such a large distribution are often at risk of cutting the distribution. As also noted above, a distribution cut constitutes a double-whammy to your portfolio, so we must be very comfortable that the distribution is very unlikely to be cut.
Now that we have concluded that the distribution is as safe as reasonably possible, let’s study the company’s financials in more detail.
USAC’s Financials, Metrics and 2019 Guidance
In order to understand USAC’s financials, we need to consider the fact that a year and a half ago (on 4/2/18), USAC acquired “CDM,” the compression business previously owned by Energy Transfer (ET), a large pipeline MLP. The CDM acquisition essentially doubled the size of USAC, increasing total “compression horsepower” from about 1.6 million HP to over 3 million HP.
The CDM acquisition makes year-over-year comparisons difficult but several points are fairly obvious. First, it was stated in the conference call 8 months ago that “the CDM integration is substantially complete.” (Conference call 2/19/19). The fact that management was able to integrate 1.6 million horsepower into USAC’s operational platform in three quarters is pretty impressive. Further underscoring USAC’s excellent execution is the fact that USAC’s horsepower utilization has averaged around 95% in the past year (“utilization” refers to the percent of total company horsepower that is leased out and earning revenue; a “utilization” rate of 95% is basically the maximum utilization achievable) This becomes even more impressive when you consider the fact that its closest peer (AROC, another very good compression company and stock) had a still-very-good utilization rate under 90%. As Eric Long (CEO) put it, “Utilization in the mid 90% area means that we’re effectively sold out [of compressors to lease out. JY.]”
Also reaffirming USAC’s quality execution is USAC’s gross operating margin of 68%, which is again better than any peer. This high operating margin is partly due to the fact that market demand for compression services (especially the super-high-horsepower–2500 HP and above–compressors in which USAC specializes) exceeds the supply, giving USAC pricing power, which expands margins, of course. USAC collected an average of $16.60/HP/month in Q2 ’19, up from $16.17 in Q3 ’18, an annual increase rate of about 4%.
Adjusted EBITDA (a metric commonly used in valuing MLP’s) was $320 million in 2018, with guidance for 2019 at $390 to $410 million. Using my EBITDA projection of $405 million for 2019 yields a 27% increase in EBITDA from 2018 to 2019. Distributable cash flow (“DCF”) was $189 million in 2018 and is being guided to a range of $190 to $210 million in 2019. Using my DCF projection of $207 million for 2019 yields a 10% increase in DCF from 2018 to 2019.
Bank covenant leverage (a measure of indebtedness) has averaged about 4.5 in the past year, and is expected to come down a bit in 2020. Generally, a leverage ratio under 5.0 is considered acceptable, and a leverage ratio under 4.5 would be considered good by most MLP investors.
Finally, USAC will add 47,000 horsepower in the second half of this year, and has already ordered 48,000 for the first half of 2020, all of which is already committed to customers (USAC never orders compressors on a “spec” basis-they only order compressors that have been ordered by a customer). Those horsepower will increase overall fleet horsepower by about 3% from July 1, 2019 to June 30, 2020, which will obviously add to revenues, EBITDA and DCF progressively over the next 12 months, and beyond. This growth rate (of about 95,000 HP over 12 months) is about a third less than the addition of 132,000 HP in calendar 2019, and is reflective of the slowdown in the growth rate of NG production between 2019 and 2020 (compared to 2018 production growth).
USAC has not provided capex/horsepower-growth guidance for the rest of 2020, but I’m guessing that HP growth in the second half of 2020 will also fall in the 50,000 range. This will likely mean that growth capex expenditures-which are at $140 to $150 million in 2019-will decrease to approximately $100 million in 2020 (this is my estimate, not USAC guidance). A decrease in 2020 growth capex should substantially increase DCF in 2020, which will increase the distribution coverage ratio in 2020. The lower capex will release those $50 million for further debt reduction in 2020 since I do not believe that USAC will (or should) increase its already-sky-high distribution (although I suppose opportunistic buybacks are a possibility).
In summary-and in answer to the question posed by the title of this section-USAC’s financials and guidance do offer advantages over other companies that pay high dividends. Those advantages can be summarized as follows:
- USAC is that unusual company that pays super-high dividends (distributions) but does not appear likely to cut them given increasing revenues, EBITDA and DCF in 2019 and 2020.
- Although it may seem counterintuitive, the fact that compressor growth rate will slow in 2020 is also a positive, increasing DCF (in essence, free cash flow) which can be used to pay down debt or opportunistically buy back stock.
To illustrate the above points we can look at USAC’s recent financial performance. In the first half of 2019, USAC generated $108,914,000 in DCF and paid $94,227,000 in distributions (please see p. 33 of the 8/14/19 presentation, , Presentations | USA Compression Partners, LP), resulting in a 1.2 coverage ratio, leaving another $14.6 million of DCF (free cash flow) after all distributions were paid. With average sequential price increases of about 1% per quarter, and with another 95,000 horsepower to come online and start generating incremental DCF between July, 2019 and June, 2020, it is very likely that DCF over the next 12 months will be meaningfully greater than DCF over the past 12 months.
Step 6 – Income Tax Considerations
This section is especially directed to investors who are unfamiliar with MLP’s and the tax benefits and demerits of MLP’s.
Many investors who comment on MLP articles often ask the question as to whether the company being discussed issues K-1’s (as do most MLP’s) or a MISC 1099 (as do dividend-paying C corps). Because it is an MLP, USAC issues a K-1, a fact that some investors dislike because of the supposed extra hassle involved in dealing with K-1’s. From my perspective, there are huge tax advantages to owning most K-1-issuing MLP’s such as USAC.
The most important advantage is that distributions are tax-deferred (the comments I am about to make are extremely generic and may not fit your own tax situation. Please consult a tax professional to get actual tax advice!). This is because the distribution is considered to be a “return of (your) capital”-the amount you paid when you bought the stock. As you continue to receive distributions, your basis in your stock keeps dropping.
When the basis reaches zero (i.e., when the amount of distributions you have collected over the years matches the amount you initially paid for the stock), you start paying tax on your distributions. You also pay tax when you sell your position, at which time your capital gain is larger than it would otherwise be because the distributions you have been receiving have been lowering your basis in your stock. But you’re still way ahead because (in general, your case may be different), (A) capital gains tax rates are much lower than ordinary income tax rates, and (B) you have deferred paying tax for many years, which means you have been able to make a return on money that otherwise would have gone to the IRS. If you use that money to buy more shares of a high-dividend-paying stock, you are doubly ahead.
But what about the K-1 hassle some investors complain about? Well, I can’t speak for others, but here is how it worked for me earlier this year when I filed my tax return. I owned 3 MLP’s in 2018-USAC, ET and EPD (the only one I still own now is USAC). Each company mailed me a K-1 package consisting of about 5 pages. USAC and EPD were ridiculously easy-I didn’t even have to read the instructions because I went to their website, downloaded a .txf file and then I imported that txf file into my Turbotax Deluxe program. Once imported, Turbotax put the numbers where they needed to go on various forms in my return and that was it. The whole process for USAC’s and EPD’s K-1’s together took me about 10 minutes.
ET’s K-1 was more complicated because there was no downloadable txf file, and because you had to input numbers by hand for 4 different ET entities. ET’s K-1 by itself took me about 20-25 minutes.
But the good news for me was that I paid just a few dollars of income tax on about $30,000-worth of distributions (one of my MLP’s earned some interest which was taxable to its unitholders).
Like I said before, each person’s tax situation is different, but in my case, it was well worth it to me to work an 40 extra minutes on my tax return (and spend $30 on Turbotax Deluxe) in order to be able to defer (for many years) what otherwise would have been about $10,000-worth of income tax. By the way, this is not a commercial for Turbotax-other tax-prep software may achieve the same results, although my only experience is with Turbotax.
Step 7 – Risks
As the reader has gathered from the foregoing comments, I view USAC as a fairly safe way to get
(A) an outsized current and steady return via tax-advantaged distributions, combined with
(B) the possibility of a small but meaningful capital appreciation of 5-10% per year, making for a total tax-equivalent return approaching 20% per year. However, nothing is risk-free and I want to discuss some of the risks here.
First, the whole energy field is unloved by investors and there is a reasonable “risk” that this may not change. I put “risk” in quotes because this “risk” is obvious-ie, were this not the case, USAC’s stock price would be $35 (instead of $17.36) and it would be yielding 6%, rather than 12%. However, I include this in the “risk” category because if the energy space becomes even more hated than it is already, that may kill any capital appreciation potential for this stock.
Second-and this also is not really a “risk” but more like a caution-my crystal ball for USAC only looks out to 2020, so I am not saying you should buy USAC and hold it for decades (indeed, I would never make that recommendation for any stock). Although the EIA looks out to 2050 in their predictions, I think doing that is a fool’s errand. Macro conditions can change so quickly that it is difficult to predict commodity pricing/demand and global geopolitical events a month hence, much less more than a year out.
Incidentally, a major reason for the 2020 expiration of my crystal ball functionality is that (without getting into politics too much), if the Democrats were to sweep the presidency and both houses of Congress in next year’s elections, the perception in the market may be that the energy space is dead, and stock prices of energy-related companies may reflect that perception. The reality will be different, of course-people are not going to stop heating their homes with natural gas in 2021, nor will gas-fired power plants stop shipping electricity to their customers, nor will industry stop using NG to run its factories, etc.-regardless of who is in office. But stocks are often priced on perception rather than reality, so whether you view this as a current “risk” or not, this will certainly be something I will re-evaluate in another 12 months.
A third “risk”-although this shouldn’t be so-if the stock market tanks (as some people believe is imminent), USAC’s stock price will drop right along with the market, despite the fact that its income and ability to pay its distribution will likely be unaffected (for the reasons discussed at the beginning of this article-ie, that NG production will be increasing annually for years to come and therefore, USAC’s revenues/DCF/ability to pay the distribution should continue).
Step 8 – Putting It All Together-Valuation Analysis
In deciding whether to invest in a company, my main focus is on total expected return in the next year. Generally, the total return is composed of a small dividend (3-4% probably being an average) plus a bigger anticipated return based on capital appreciation of the stock. Capital appreciation is more likely when overall market valuations are low, as was the case at the beginning of the recovery from the Great Recession. The capital appreciation component becomes less certain as stock market valuations get stretched-as they are now. That is why a higher-and fairly secure-dividend is more important to me in the current market environment.
In addition, I view USAC’s business as a recession-resistant business because as NG production continues increasing in 2019 and 2020, the demand for compression services must also increase.
Therefore, in today’s market environment, I put more value on the relatively certain 12% return from USAC than I would on a company that offers a 4% dividend with a greater potential for capital appreciation. A bird in the hand beats two in the bush, so to speak.
Obviously, if the energy space becomes more loved (less unloved?) and/or if investors realize that – given the high probability that USAC will continue to pay its outsized $2.10 annual distribution-USAC should be trading at an 8% or 10% yield rather than a 12% yield it is possible that USAC goes to $21 (resulting in a 10% yield) or to $26 ((resulting in an 8% yield).
Although it could happen (and the efficient market hypothesis says it should happen), I wouldn’t bet on USAC going either to $21 or $26 in the next year, given how poorly the energy space has traded in the past few years. The low valuations (relative to metrics) have been especially true for MLP’s-for reasons which were especially valid from 2014 to 2018 but which I think are less valid now.
In summary, I view this stock as one with a likely annual 15-20% tax-advantaged return, which would probably beat just about every money manager in the stock market today. This conclusion obviously underlies the title to this article. Note that a 15% tax-equivalent return implies almost no capital appreciation, which is certainly within the realm of possibility given how hated the energy space is today.
Step 9 – What’s a Good Entry Point?
This is a very difficult question to answer and everything I am about to say should be taken with a grain (or more than a grain) of salt because my confidence in what I’m about to say is low.
I have been following USAC’s daily trading for over a year now, and it has been extremely volatile, which is very strange for a stock with such a high distribution yield. In the past 8 months, it has ranged from the mid $15’s to the mid $18’s. It is hard to tell the extent to which USAC’s volatility has been due to China trade issues, general stock market volatility, NG/oil prices or something else. For the reasons notes above, none of these factors have any meaningful impact on USAC’s increasing revenues, EBITDA or DCF, but they probably all do impact USAC’s stock price.
Because investors want to receive the 52.5-cent distribution, USAC tends to run up prior to earnings announcements, and then drop after earnings. This time around, the distribution will be paid on 11/8/19 to unitholders of record as of the close of business on 10/28/19. Therefore, barring any major market calamities, I think there’s a reasonable chance USAC will run up the week of 10/24/19, and might well hit $18 or above (as it has previously in anticipation of distribution payments).
The question is what happens the week after USAC goes ex-dividend. In the past, the post-ex-dividend drop has ranged from about $1 to over $2, although it has always recovered (and gone higher) after the drop.
Given (1) the precipitous fall in rig count, (2) the plateauing of shale oil production, (3) the expectation that crude inventories are poised for a drop between now and the end of this year (and probably beyond), (4) the reasonable possibility that OPEC will agree to further reduce its production at the upcoming December meeting, and (5) the potential of further aggressive action by Iran, some believe (myself included) that WTI will be higher in a month or two than it is now. If that happens, and if some cold weather pushes NG pricing to the upper $2’s, the sentiment in the energy space may improve and USAC may not drop so much after earnings this time around.
I expect USAC to report (on 11/5/19) per the upper range of guidance, which probably isn’t going to have much impact on the stock price one way or the other. But the more quarters that USAC reports well, the more comfortable investors might be with the stock, and that may prevent a big drop in USAC’s stock price after earnings.
At the end of the day, what we are talking about here is market timing, which is notoriously difficult to do. I claim no special expertise in market timing but I have tried to delineate above some factors for you to consider so that you can determine for yourself the proper entry point.
Disclosure: I am/we are long USAC, AROC, CCLP, GPOR, CRZO. 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: ADDITIONAL DISCLOSURE: I am not an investment advisor nor do I hold out myself as some sort of expert in this field. I am a retired emergency room doctor whose primary business activity in the last 30 years has been buying and running low-income apartment complexes.