USA Compression Partners, LP

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 2/5

USA Compression Partners, LP is a Delaware limited partnership providing natural gas compression services to customers in the oil and natural gas industry.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: USA Compression Partners, LP (USAC) provides natural gas compression services through its owned fleet of compression equipment. This equipment is used to facilitate the extraction and transportation of natural gas, which is a vital energy commodity. The company’s services are employed throughout the lifecycle of a natural gas well, from initial extraction to late-life enhanced recovery operations. This makes the company dependent on activity level and trends in the oil and gas industries. The company primarily operates in the USA. USAC is a limited partnership with a general partner called USA Compression GP, LLC. The Partnership Units are traded on the New York Stock Exchange under the ticker “USAC”.

Key segments of USAC include large-horsepower compression, small-horsepower compression, and field services. USAC owns one of the largest fleets of compression equipment in the industry.

Revenue is generated primarily through the provision of compression services.
Contracts are typically structured with fixed fees, offering stable income. The company’s customers include exploration and production firms as well as midstream companies.
The company’s customers include upstream, midstream and downstream companies.
The main value drivers are: the number of well connections, the amount of gas being processed, and the pricing charged for its services.
USAC’s compression fleet consists mostly of compression units using natural gas engines.
The majority of its revenues come from recurring service fees and not from the sale of equipment.
Geographic concentration is primarily in Texas, the Permian Basin and Louisiana.
Most of its contracts are “take-or-pay,” meaning USAC gets paid whether the customer operates the leased equipment or not.
Most new contracts are more short-term contracts.
The contracts typically includes a price-escalator provision.

Industry Trends & Competitive Landscape: The natural gas compression industry is closely tied to the energy sector, particularly to the production and transportation of natural gas. Demand is driven by drilling activity, production volumes, and the need for pipeline transport. The industry has been showing robust demand. The major themes within the industry are the shift towards cleaner energy sources and the push to reduce carbon emissions, leading to investments in more efficient equipment. USAC operates in a competitive environment that includes other equipment leasing and service companies, making differentiation important.

The company’s business is highly correlated with crude oil and natural gas prices and production. The higher the activity in the energy sector, the better it is for USAC.

There is not a strong level of customer loyalty as customers often lease from whoever is cheapest or offers the best solutions for their needs.
The main risks are: increased regulations, a drop in crude and natural gas prices, reduced production, and increased competition.
USAC is not the largest player in the industry, with larger players having more purchasing power and capacity, but has maintained a notable portion of the market share.
Consolidation is increasing in this industry and the size of companies matters, especially in regards to ability to purchase equipment, service locations and overall bargaining power.
Most of their competition does not have the same focus on large-horsepower compression, which is something USAC has.
USAC has a lot of specialized knowledge in compression technology.
USAC does have a high level of operational know-how and a strong maintenance program.

Financials: USAC’s revenue is primarily driven by contract compression services, and the company’s results can vary greatly depending on activity in the energy industry.

Operating revenue for 2022 was $722.4 million, representing a significant increase from 2021. However, growth has been volatile.
Net income for the year ended December 31, 2022, was $34 million, compared with a net loss of $158.6 million in 2021. This turnaround was due to an increase in demand and higher sales prices. But the company is yet to show high and stable profitability.
USAC has a high debt level and a negative book value due to accumulated losses.
Free Cash Flow (FCF) and adjusted EBITDA have been improving recently.
USAC spends heavily on maintaining their fleet and upgrading or acquiring new compression units.
Rising fuel costs can cause a drag on profitability, but contracts are usually indexed to crude oil prices and can mitigate this risk.
Their most recent revenues have improved over the past few quarters showing a rebound in the activity of the company.

Recent concerns/controversies:

USAC faced difficulties during the 2020 downturn when oil and gas prices declined and that lowered the demand for the compression units.
There was a lot of uncertainty in the market as to whether long term crude oil and natural gas demand would be sustained due to growing renewable sources of energy. But the recent supply chain issues and increased oil prices have calmed fears for some time.
A lawsuit regarding certain aspects of the contracts, which has been ongoing and could be settled in an unfavorable way.

Moat Rating: 2/5 USAC possesses a narrow moat, mostly tied to switching costs and specialized expertise. They are not a commodity-product and therefore have some advantages over other competitors. Their contracts, especially the longer ones can be hard for a customer to unwind. Also, having a team of experienced engineers that know how to maintain the compression units creates a moat around their knowledge base. But they don’t have any particular size advantage or brand, which could make them vulnerable to larger companies that want a piece of the market.

Intangible Assets: While USAC may have some intangible assets related to customer relationships, and know-how in the business they are not strong enough to be categorized as a real moat. It is more of a company-specific knowledge than something that is easily protectable by law, like a patent.
Switching Costs: USAC does provide contracts that have switching costs for the customers, and even though this does create some form of moat, the switching costs is limited. A customer can easily switch to another company if the cost/benefit favors them.
Network Effects: There are no network effects for USAC. The business model has no network effect that could hinder competition.
Cost Advantages: USAC does not possess a true cost advantage compared to its peers. They operate with high capital costs and fluctuating commodity and raw material prices. While they may have process-based efficiencies, other companies can easily implement similar process-based efficiencies, making it non-proprietary or sustainable. Also, smaller companies can also operate at a lower cost if they are using less debt.
Size Advantage: USAC has a relatively large fleet of compressors but is by no means the biggest player in the industry. And even with their current size, it is not that difficult for a competitor to enter into the same business and compete in their targeted locations.

The presence of “take-or-pay” contracts is beneficial and does serve as some kind of moat because it gives guaranteed revenue and reduces the financial risk of a customer not using the unit. But it does not eliminate risk completely.

The nature of compression is that they can move their compression units to a different customer within a relatively short time period, therefore, any customer may choose to switch providers or negotiate for a better price.

Legitimate Risks to the Moat and Business Resilience:

Dependence on Commodity Prices: The company’s financial health is strongly tied to crude oil and natural gas prices. The dependence on the energy sector, and especially natural gas prices, leads to large uncertainties and fluctuations in profitability and growth. A decline in prices can significantly reduce demand for compression services. The dependence on commodity prices makes it hard to have stability of revenues.
Contract Duration and Flexibility: The company now has a tendency to issue more short term contracts. These contracts can provide less revenue over a long period of time and may be easier for customers to unwind. This will increase the competition and the volatility of the business.
Competition: The industry is not highly concentrated and there are other notable players and private companies that provide similar services, which means competition is always a risk. There is no guarantee they will be able to defend their share of the market, as a superior company could enter and provide better pricing or services.
Economic Downturns: Recessions or slowdowns in economic activity could curtail energy production and transportation, affecting USAC’s revenue. A large slowdown could severely harm the company.
Technological Changes: Changes in drilling, extraction, or compression technology could make USAC’s equipment or business model obsolete.
Regulatory Changes: Environmental and regulatory changes could impose added costs on operations and the cost of capital.
High Debt Load: A large amount of debt leaves the company vulnerable to large interest rate swings or liquidity issues.
Financial Reporting or Other Fraud: If a company experiences any kind of fraud from its leadership it would drastically reduce value in the share price.
Inability to Acquire Competitors: Other companies may have better access to capital and a better credit rating, making it difficult to expand and consolidate the business.
Loss of Key Customers: Since customers are not bound for a long period of time, they could decide to end their contracts, without having to pay for them. This could cause a large decline in the revenue of the company.

Business Resilience: USAC has proven resilient as they are still operational, have a large fleet and continue to operate through multiple recessions and recessions. If anything changes though, such as the company losing a large customer base, it could have severe consequences to their future revenue and operation.

Understandability: 3 / 5 The core business of USAC is relatively straightforward: they lease and maintain natural gas compression equipment. However, the complex and intricate financial statements, especially in regards to debt financing, debt covenants, and the high level of technical know-how needed in the business can make it harder to truly fully understand and analyse the company. The business is also very reliant on outside market conditions making it even harder to understand its profitability and growth.

Balance Sheet Health: 2 / 5 USAC has a lot of leverage on its balance sheet and a negative total equity due to past losses, which makes their overall health less than ideal. The amount of debt it has is very substantial in relation to its assets, and it is a risky financial position that could lead to trouble if there is a downturn. Recent improvements to the free cash flow is great, but the current balance sheet is still weak.

Total debt to total capitalization is around 84%.
The company has a history of losses and therefore its overall equity has become severely negative.
The company has a substantial amount of debt which increases the riskiness of their company.
The company has made a great effort to manage debt by swapping it out for debt that is more flexible and easier to pay back.
They need to manage their debt load carefully, in order not to cause a liquidity issue or force a bankruptcy.
In general, the debt is used as a strategic leverage, but can easily become a problem if margins or revenues suddenly drop.

Their operating model needs to produce high cash flow margins for them to maintain this debt structure.