Archrock Q2 2024 Earnings Call Transcript

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Provided by Quartr
July 31, 2024

There are 7 speakers on the call.

Operator

Good morning. Welcome to the Archrock Second Quarter 2024 Conference Call. Your host for today's call is Megan Rapine, Vice President of Investor Relations at Archrock. I will now turn the call over to Ms. Rapine.

Operator

You may begin.

Speaker 1

Thank you, JL. Hello, everyone, and thanks for joining us on today's call. With me today are Brad Childers, President and Chief Executive Officer of Archrock and Doug Aaron, Chief Financial Officer of Archrock. Yesterday Archrock released its financial and operating results for the Q2 of 2024. If you have not received a copy, you can find the information on the company's website at www.artruck.com.

Speaker 1

During this call, we will make forward looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934 based on our current beliefs and expectations as well as assumptions made by and information currently available to Archrock's management team. Although management believes that the expectations reflected in such forward looking statements are reasonable, it can give no assurance that such expectations will prove to be correct. Please refer to our latest filings with the SEC for a list of factors that may cause actual results to differ materially from those in the forward looking statements made during this call. In addition, our discussion today will reference certain non GAAP financial measures, including adjusted EBITDA, adjusted gross margin, adjusted gross margin percentage, free cash flow, free cash flow after dividend and cash available for dividend. For reconciliations of these non GAAP financial measures to our GAAP financial results, please see yesterday's press release and our Form 8 ks furnished to the SEC.

Speaker 1

I'll now turn the call over to Brad to discuss our truck's 2nd quarter results and to provide an update of our business.

Speaker 2

Thank you, Megan, and good morning, everyone. Archrock's 2nd quarter performance reflects the earnings power we've built through our investment in high quality assets, exceptional customer service and efficient execution. The long term and year over year strength and durability we see in our overall performance and as reflected in our 2nd quarter results is also supported by the affordability and abundance of U. S. Natural gas, which will continue to fuel growth in its demand, use and production.

Speaker 2

And this strong performance as well as the strength and durability are both further bolstered structurally by the continued capital discipline being employed across the energy sector. Now with that backdrop, let me start today's call with a summary of key highlights from the Q2. Our net income of $34,000,000 was up from $25,000,000 in the Q2 of 2023. Adjusted EBITDA of $130,000,000 was up 15% versus the prior year period. The increase was driven primarily by higher pricing, combined with a sharp focus on cost management leading to strong profitability.

Speaker 2

We maintained our sector leading financial position, including a leverage ratio of 3.2x. We continue to deliver meaningful returns to our shareholders. Our quarterly dividend per share was up 6% compared to a year ago, all while maintaining robust dividend coverage of 2.6 times for the quarter. This was a great quarter for Archrock. Thanks to a fantastic team of dedicated employees who work hard every day to deliver safe and excellent service to our customers and attractive returns to our shareholders.

Speaker 2

And now with the acquisition of Tops that we announced last week, we will further enhance our position as the premier contract compression services company in the U. S. And I'll expand on that in a bit. Turning to Archrock operations, market conditions for compression remain highly constructive predominantly in oil plays with associated gas production like the Permian Basin. The robust market is reflected in our Q2 contract operations operating and financial results.

Speaker 2

Our fleet remained fully utilized with utilization exiting the quarter at a rate of 95%. Booking activity increased sequentially as we continue to build an order book into 2025. We expect to see sustained compression booking demand well into the future as our customers plan for the call on natural gas production to support LNG export capacity growth and incremental electric generation demand from AI and data centers. On pricing, with utilization at historic highs and continued strong booking activity, we're maintaining the pricing prerogative and capturing additional rate increments. The 2nd quarter marks our 11th consecutive quarter of sequential increases in our monthly revenue per horsepower, which increased to $20.85 Continued price increases and strong cost control drove adjusted gross margin percentage to 65%, up 300 basis points year over year and consistent with the prior quarter.

Speaker 2

The Aftermarket Service segment had another solid quarter. Revenues totaling $45,000,000 remained elevated as great service is driving repeat business with customers. 2nd quarter adjusted gross margin of 22% exceeded our full year guidance expectation as we continue to focus on high quality and high margin work. From our 1st rate customer base to our highly standardized fleet and excellent customer service we are known for in the field to our most recent digitization and emission reduction efforts, the actions we've taken to enhance our business should benefit our performance for years to come. The acquisition of Tops aligns with this strategic focus and is an exceptional opportunity to expand our contract compression operations, earnings and cash available for dividend.

Speaker 2

With TOPS, we're adding 580,000 horsepower of Young assets, including approximately 500,000 operating horsepower and a substantial and contracted backlog of new equipment. As we previously discussed, this strategic and immediately accretive acquisition carries 4 main benefits. 1st, the acquisition of highly of high quality assets with contracted cash flows as meaningful low risk growth. The top fleet has an average age of 3 years, is 95% utilized and backed by fee based contracts with blue chip customers. 2nd, the acquisition enhances our scale and complements our existing Permian Basin compression capacity.

Speaker 2

The addition of TAPS is expected to increase Archrock's Permian Basin Compression capacity by 30% to approximately 2,200,000 operating horsepower. 3rd, this acquisition accelerates the growth of our electric motor drive fleet and augments our internal electrical expertise. SAS is the leading provider of electric motor drive compression. With this acquisition, we expect our electric compression fleet to increase to 648,000 horsepower or 15% of our pro form a fleet. And 4th, this transaction is consistent with our financial and capital allocation priorities and we expect it will facilitate the accelerated return of capital to shareholders.

Speaker 2

We're buying a rapidly growing business with a substantial and contracted backlog. And we expect the acquisition to be more than 10% accretive to earnings per share and at least 20% accretive to cash available for dividend per share in 2025. TAS has both high caliber equipment and a talented team that we're excited to welcome to our trial. The transaction is expected to close by the end of 2024 and we're confident in our ability to effectively integrate the acquired assets into our existing business. In summary, with today's robust market of growing natural gas production and compression demand, one of our top priorities has been investing in high quality and high return compression assets.

Speaker 2

And equally as important, we've been funding these investments within our cash flow so that we've been able to deliver on our commitments to increasing cash returns to investors while maintaining a strong balance sheet. The acquisition of Tops aligns with this strategic focus and is an exciting milestone for Archrock that builds on the meaningful progress we've made orienting our business for the future and for long term success. With that, I'd like to turn the call over to Doug for a review of our 2nd quarter performance, 2024 standalone guidance and financing strategy for the Tops acquisition.

Speaker 3

Thanks, Brad, and good morning, everyone. Archrock delivered another strong quarter of financial results. Net income for the Q2 of 2024 was $34,000,000 This included a non cash $4,400,000 long lived and other asset impairment as well as transaction related expenses of approximately $1,800,000 We reported adjusted EBITDA of $130,000,000 for the Q2 2024. Underlying business performance was strong in the second quarter as we delivered higher total adjusted gross margin on a sequential basis. For the 2nd quarter, growth capital expenditures totaled $62,000,000 bringing year to date growth CapEx to $140,000,000 We expect our 2024 growth capital will be first half weighted.

Speaker 3

Maintenance and other CapEx for the Q2 of 2024 was $29,000,000 bringing the total for the first half of twenty twenty four to $51,000,000 Turning to the balance sheet. We exited the quarter with long term debt of $1,600,000,000 Our leverage ratio at the end of the quarter was 3.2 times calculated as total debt divided by our trailing 12 month adjusted EBITDA. As Brad mentioned earlier, we are acquiring TOPS for total consideration of $983,000,000 which will be funded with a combination of $826,000,000 in cash and $6,870,000 newly issued common Archrock shares to the seller. Archrock intends to fund the $826,000,000 cash portion of the total consideration with a combination of equity and debt. On the equity portion, last week we announced the pricing of a common stock offering raising net proceeds of $256,000,000 at an offering price of $21 per share.

Speaker 3

The funding structure keeps us on track to achieve our financial targets including maintaining a consistent leverage ratio of between 3x and 3.5x. Post transaction announcement and equity raise, all three rating agencies reaffirmed their Archrock credit ratings and outlook. The strong financial flexibility I just described continued to support increased capital returns to our shareholders. We recently declared a 2nd quarter dividend of $0.165 per share or $0.66 on an annualized basis. This is consistent with the Q1 of 2024 dividend level and up 6% versus the year ago period.

Speaker 3

Cash available for dividend for the Q2 of 2024 totaled $72,000,000 leading to an impressive quarterly dividend coverage of 2 point 6 times. Importantly, we believe the increase in pro form a discretionary cash flow from the addition of Topps will further enhance our financial flexibility and capacity to increase dividends to our shareholders over time. As you saw in our earnings release issued yesterday, Archrock reaffirmed its full year 2024 annual EBITDA and capital expenditure guidance. Our guidance excludes the pending acquisition of Topps. We plan to announce our expectations for the combined company once the transaction closes by the end of 2024.

Speaker 3

Excluding TOPS, our 2024 adjusted EBITDA is expected to range from $510,000,000 to $540,000,000 which represents an increase of 17% compared to $450,000,000 in 2023. 2024 growth CapEx is expected to total approximately $190,000,000 This is flat compared to the growth CapEx of $190,000,000 in 2023. Our full year 2024 maintenance CapEx forecast of $80,000,000 to $85,000,000 and other CapEx forecast of $20,000,000 to $25,000,000 both remain unchanged. In closing, the market remains as strong as we've ever seen it and Archrock is in the strongest position in the company's 70 year history. We have an opportunities rich market and expect to invest in high return opportunities, profitably grow our business while prioritizing and growing shareholder returns and maintaining an industry leading balance sheet.

Speaker 3

We are excited to welcome the TOPS team and we look forward to building an even stronger Archrock together for the benefit of our employees, our customers and our investors. JL, with that, we are now ready to open the line for questions.

Operator

Thank you. The floor is now open for questions. Your first question comes from the line of Jim Rolleeson of Raymond James. Your line is open.

Speaker 4

Hey, good morning guys.

Speaker 2

Good morning.

Speaker 4

Brad, so year to date you've obviously spent well more than half of your growth CapEx, which implies a softer second half on that front. But just curious, your horsepower totals haven't moved that much in the active category so far. Just maybe and I know you've also realized some proceeds from selling some stuff still, but maybe just a little color on kind of fleet dynamics like how much horsepower you've delivered, how much has been put in the field, how much have you sold, just kind of some color on that if you don't mind?

Speaker 2

Sure. Thanks, Jim. On the overall position of the horsepower in the business, we're super excited to just maintain the 95% utilization rate that we've achieved. One of the impacts of that, as you can imagine, it does mean that we've put to work a ton of the idle fleet horsepower that we previously had maintaining it at a high rate. And that also means there's less horsepower in the fleet to go back to work.

Speaker 2

So the trade off is we get to book less of that, but it's because it's active, working and highly profitable. So that's one dynamic that you're seeing on the relatively flat horsepower quarter over quarter. The second thing we'll note is that the market has definitely cooled a bit as we've seen a little bit of give back in some of the dry gas plays. Fortunately, as you can see in the numbers, it's completely immaterial into our overall fleet position as the vast bulk of our horsepower is going to work in the liquids rich place, 60% of it goes to work in the Permian on a bookings basis right now. So those are a couple of the dynamics we've seen and what I think is a relatively flat period of time.

Speaker 2

But finally, on a really good news front, bookings has continued to remain robust. And so even though the horsepower activity itself is a little bit flattish for us in this current period, what 2025 offers is still a very robust bookings set from our customers as they prepare for future natural gas production growth starting in 2025 as LNG projects come online. That's a lot of what you're seeing. And then finally, I'd point out that actually you're right, the CapEx budget for the year 2024 was definitely front end loaded.

Speaker 4

Yes. I appreciate that color. And just kind of since you brought up the new build part of that equation or new orders, just maybe kind of a status update on what lead times look like today and another thing that's been helping in addition to the tight market drive pricing is just the fact that the cost of equipment has gone up and maybe just some color on kind of what inflation has been there, is that starting to level off, etcetera?

Speaker 2

Factually, on the easy stuff, lead times are in the 40 weeks, plus or minus depending upon the category of equipment. But we would describe it as a very normalized market. Inflation has returned to more historic levels, and that is for equipment coming into the system in the 3% to 5% range on a per item increase basis. That's our expectation. It's what we're seeing and it's our expectation.

Speaker 2

So that's the easy stuff to point out. But what we also see then is just robust bookings continuing going forward with that. What's exciting about the market today though is that it's not about lead times, it's constraining the market. Equipment costs are definitely up and that means the price of bets has gotten bigger and further reinforced a lot of discipline in the market. Capital still remains at elevated levels, so that cost is enforced discipline in the market.

Speaker 2

But what all of this goes to is the thing we think is really driving a lot of discipline in the market is the investors demand and focus on free cash flow generation, strong balance sheets and continued growth in returns to investors. That level of discipline means that no one's going to borrow expensive money to place expensive bets without the security of a commitment and a booking with a contract in place with a customer already. That's what's really driving the market. We think it's about capital discipline. We don't think it's about supply chain constraints.

Speaker 4

Got it. Yes, it's certainly nice to see and I'll let somebody else ask questions. Appreciate the time.

Speaker 2

Thanks, Jim.

Operator

Your next question comes from the line of Steve Farizzani of Sidoti. Your line is open.

Speaker 5

Good morning, Brad and good morning, Doug. Appreciate all the detail on the call. Obviously, impressive continued growth on the revenue per horsepower. Just trying to get a sense now, are we getting closer to spot? Is there still a lot of room to go as you reset pricing on previous contracts and with the new capacity coming online?

Speaker 2

At these levels of high utilization, we still believe we have pricing prerogative. Spot pricing remains elevated compared to where the entire fleet is and we will continue to opportunistically bring the fleet up to market pricing as our contracts permit us to do so over time. And on the good news front, when we evaluate our ability to either increase pricing because the contract is eligible for it, because it has a renegotiation in it or it has an automatic price increase in it, or we have the ability to drive pricing under the contract terms. We estimate that over the next 18 months, we'll still be able to increase pricing on eligible to increase pricing on 80% to 90% of the horsepower in the fleet. So over time, we expect to continue to work on bringing that gap, narrowing that gap.

Speaker 2

Excellent.

Speaker 5

You talked about you have less idle capacity to bring back. The only number that surprised me on the quarter was the higher maintenance CapEx yet. Your guidance didn't change, which implies this is by far the highest quarter. Usually that's because of higher make ready. Is that what happened?

Speaker 5

Did you just happen to have more idle capacity coming back this quarter? Or was there something else in that higher maintenance CapEx?

Speaker 3

No, Steve, I definitely would not read anything into that. I think we had some parts expense, some timing in the quarter, some of that can vary just depending on when the work gets done. So as you said, we think our current guidance is absolutely good and I wouldn't read into anything beyond that.

Speaker 5

Okay. That's helpful. And last one for me just on the continued strength with the aftermarket business. Is this a new reasonable run rate for your aftermarket? And can you maintain these above 20% margins?

Speaker 5

What's your outlook? Any changes?

Speaker 2

With the market as tight as it is, not just in contract operations, but also in the fleets of our customers, our customers are very focused on maintaining their horsepower candidly better than they have in the past. There's less idle capacity and so that's driving a lot of really good service activity, which is higher margin and higher profit work to our truck. And our team is doing an excellent job both capturing it and executing on it. So I believe that as the market remains at these elevated levels of utilization that translates into strength and continued profitability both on the revenue line as well as in the profit we can obtain in our aftermarket service business.

Speaker 5

Thanks, Brad. Thanks, Doug.

Speaker 2

Thank you.

Operator

Your next question comes from the line of Selma Akyol of Stifel. Your line is open.

Speaker 6

Thank you. I wanted to follow-up on a couple of comments. In your prepared remarks, I think you talked about the market is cooled, some give back in dry gas plays, and you're repositioning those assets into liquid plays. Can you maybe quantify how long that takes and how much horsepower are we looking at? And should we see some sort of bump from redeploying those assets in the 3rd or 4th quarter?

Speaker 2

Thanks, Amit. We should not expect to see a bump. You should not expect to see any real impact to the redeployment of those assets. What I was suggesting, however, is that with the small amount of horsepower in the dry gas plays that was reduced in the quarter and we're talking about a fractional percentage of our fleet, it still has an impact in marginal growth in a period of time when equipment is not going back to work as aggressively in 2024 as it did in 2023. So I don't think you should expect to see any negative impact on that at all, Other than that equipment will go back to work probably in some of the dry gas plays, some of it will be redeployed elsewhere over time, but it's so marginal that it will not be transparent from a financial perspective or from a cost perspective is what I really should cost perspective is what I really should say.

Speaker 6

Understood. And then just following up sort of on the last questioning in terms about getting closer to spot. I think you said over the next 18 months, you get price increases on 80% to 90% of the eligible fleet. And I was wondering if I could push you and just ask how much of the fleet is eligible over the next 18 months to be repriced?

Speaker 2

That was the number between 80% 90% of the fleet should be eligible for repricing in that period of time.

Speaker 6

Okay, understood. Thank you very much.

Speaker 2

Thanks.

Operator

There are no more questions. Now I'd like to turn the call back over to Mr. Childers for final remarks.

Speaker 2

Great. Thank you everyone for participating in our Q2 review call. Archrock's underlying business performance is outstanding and we're excited about the top scale, which we believe will create substantial shareholder value. I look forward to updating you on our progress in the future. Thanks everyone.

Operator

This concludes today's conference call. You may now disconnect.

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Key Takeaways

  • Archrock reported Q2 net income of $34 million (vs. $25 million YOY) and adjusted EBITDA of $130 million, up 15% on higher pricing and tight cost management, driving a 65% adjusted gross margin (up 300 bps YOY).
  • The company’s fleet remained 95% utilized and marked its 11th consecutive quarter of sequential revenue-per-horsepower increases (to $20.85), with pricing prerogative intact and 80–90% of the fleet eligible for further rate resets over the next 18 months.
  • Announced acquisition of TOPS adds 580,000 hp of young, 95% utilized assets with a contracted backlog, boosting Permian capacity by 30% and electric compression to 15% of pro forma fleet, expected to be >10% EPS accretive and >20% cash-available-for-dividend accretive in 2025.
  • Maintains a strong balance sheet with a 3.2× leverage ratio, raised $256 million in equity at $21/share, declared a 6% higher quarterly dividend with 2.6× coverage, and reaffirmed full-year 2024 guidance of $510–540 million adjusted EBITDA and $190 million growth CapEx.
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Earnings Conference Call
Archrock Q2 2024
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