Q3 2023 Archrock Inc Earnings Call
Good morning, and welcome to Archrock that Cotai 2023 cockpits cool your host for today's call is Megan Repine, Vice President of Investor Relations at Archrock.
I will now turn the call over to Mr. <unk> you may begin.
Thank you Nadia 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 Aron Chief Financial Officer of Archrock Yesterday, Archrock released its financial and operating results for the third quarter 2023.
Received a copy you can find the information on the company's website at Www Dot Archrock Dot com.
During this call we will make forward looking statements within the meaning of section 21 E 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 management team, Although management believes that the expectations.
As 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 gross margin gross margin percentage free cash flow free cash flow after dividends 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.
8-K furnished to the SEC I'll now turn the call over to Brad to discuss Archrock third quarter results and to provide an update on our business.
Thank you Meghan good morning, everyone and thank you for joining our call.
We delivered excellent financial and operational results during the third quarter, which included setting several performance records.
This continues to be a tremendous market for compression.
But more importantly, the result, archrock delivered in the third quarter and the consistency in execution, we still delivered all year.
To reflect the changes we've driven across the business to enhance our fleet customer service and.
And profitability to drive improved returns for our investors.
Let me hit a few of the highlights from the quarter.
In the third quarter, we doubled our net income to $31 million compared to the third quarter of 2022.
We generated adjusted EBITDA of $120 million, which was a quarterly record for Archrock and was up 7% sequentially.
The increase was driven primarily by positive pricing and profitability momentum at our contract operations segment.
I'm also proud to share that we achieved an important balance sheet milestone during the quarter as we drove our leverage ratio to three eight times.
And we intend to drive leverage even lower next year.
We continue to increase shareholder returns, we paid a quarterly dividend per share of <unk> 15, and a half since which was up 7% compared to a year ago, all while maintaining robust dividend coverage of two six times.
In addition, we continued repurchasing shares under our share buyback authorization.
I'd now like to share my perspective on the market.
Archrock disposition and a unique segment of the natural gas value chain.
And we believe compression market fundamentals have never been better.
Similar to pipelines, we're an energy infrastructure company supplying a critical piece of infrastructure needed to move gas to market with the majority of our large horsepower equipment deployed in natural gas gathering applications.
We ran a fee based business, which is closely aligned to natural gas production volumes and nuts natural gas prices. So we're not exposed to the shorter cycle volatility facing drilling pressure pumping and completions focused services.
Looking at the outlook for natural gas production again, the biggest driver of our business, we expect to see consistent and modest growth rates in the low single digits on an annual basis.
This is being driven by two dynamics.
First we continue to see strong investment and associated gas plays in the U S like the Permian and the Eagle Ford, where the majority of our operating fleet is located.
We also believe the recent U S shell Mega deals announced by major integrated producers reinforce the competitiveness and longevity of U S shale.
Second our customers are planning critical infrastructure to support growing LNG exports from the U S. Further extending the attractive fundamentals for our industry well into the future.
As natural gas demand and production grows we're experiencing unprecedented tightness in the compression market, which we believe is driven by structural and industry wide changes to capital allocation practices.
Priorities have changed.
With capital disciplined permitting permeating the energy sector as companies look to drive moderated and profitable growth as well as consistent free cash flow to return to shareholders.
We're seeing this capital discipline by our producer and midstream customers other compression companies and even our equipment providers.
We believe this powerful combination of expected continued growth in natural gas production plus the commendable discipline, we're seeing across the industry support a constantly comparably steadier and more durable upcycle for compression and for Archrock.
Moving onto our contract operations segment, we've positioned our compression platform selling non strategic assets and investing in highly standardized large midstream compression units.
The benefits are clearly beginning to pay off in our results.
Fleet utilization exited the third quarter at 96% another record for Archrock.
We also delivered nearly 650000 active horsepower growth, excluding noncore active asset sales of 35000 horsepower.
The growth was primarily driven by Newbuild equipment deliveries as we have few idle units remaining to redeploy.
And as we continue to experience historically low levels of equipment returns from the field.
When we do receive a notice of a customer's determination to returning units most of that equipment is booked for its next job before it ever stops in its current location.
On booking activity robust customer demand is showing no signs of slowing down and our 2024 Newbuild capital is fully committed.
With lead times for new equipment still around a year the window to order compressors for delivery in 2020 for his closing and our customers are beginning to plan for their 2025 horsepower needs.
On pricing, we've now achieved sequential increases in our monthly revenue per horsepower for eight consecutive quarters.
Over this time period, our monthly revenue per horsepower is up over 17%.
The pricing trajectory remains positive and we expect to continue to make progress gradually moving rates up on our installed base next year.
We delivered an impressive third quarter gross margin percentage of 64%, which was above our annual guidance range and is now approaching peak performance during prior cycles.
This is due to a few factors.
First.
As I just highlighted we have repositioned our compression platform for a more stable and profitable future.
Second the price increases we're implementing this year are catching up with the cost increases we experienced over the last few years.
And third.
We've maintained a consistent and unwavering focus on cost management, as we grow modestly and profitably with our customers.
Turning to aftermarket services, we saw steady and strong performance, we saw solid demand and activity on the service side of the business during the quarter and profitability remains substantially higher than 2022 levels as our team focuses on targeting higher quality at higher margin activities.
Yeah.
From a capital allocation standpoint, we remain on track to deliver the enhanced framework that we laid out on last quarter's call, which is underpinned by our commitment to generate free cash flow.
Based on our current outlook for 2024, we remain setup to grow our dividend with a 2024 target of 5%.
And maintain a dividend coverage ratio of approximately two times.
Concurrently drive our leverage ratio, even lower to a range of three to three five times.
Fund our growth capital expenditures, which we currently anticipate to be approximately $160 million in 2024.
And this capital plan preserves the ability to continue to buyback additional shares.
In summary, 2023 is shaping up to be a banner year for our company and we believe we are set up for an extended period of strong and sustained performance.
Natural gas production fundamentals remain durable the compression industry is as tight as we've ever seen due to capital rationalization by both the energy industry and our suppliers and Archrock competitive financial flexibility is as strong as it's ever been.
With that I'd like to turn the call over to Doug for a review of our third quarter and to provide additional color on our outlook for the rest of the year.
Thank you Brad and thanks to all of you for joining US. This morning, let's take a look at our summary of our third quarter and then cover our financial outlook.
Net income for the third quarter of 2023 was $31 million. This included a long lived and other asset impairment of $3 million and restructuring charges of $600000.
We reported adjusted EBITDA of $120 million for the third quarter 2023, a quarterly record for Archrock.
Underlying business performance was strong in the third quarter as we delivered higher total gross margin dollars on both a sequential and annual basis.
Results further benefited from approximately $3 million in third quarter asset sale gains.
Turning to our business segments contract operations revenue came in at $208 million in the third quarter up 3% compared to the second quarter of 2023, and 22% versus the year ago period.
Operating horsepower and pricing both increased sequentially.
Compared to the second quarter of 2023, we grew our gross profit by nearly $7 million or 6%, resulting in a gross margin percentage of 64%.
This was up 150 basis points compared to the second quarter, and nearly 600 basis points year over year.
In our aftermarket services segment, we reported third quarter 2023 revenue of $46 million consistent with second quarter levels and up 6% compared to the third quarter of 2022.
Second quarter Ams gross margin of 20% was down sequentially that was consistent with annual guidance and up from 300 basis points versus the third quarter of 2022.
Growth capital expenditures in the third quarter totaled $45 million. This was.
<unk> with our previous guidance.
Previous guidance that capital investment for the year would be more first half weighted.
Through the end of the third quarter, we deployed $175 million of growth Capex and high return projects to meet the strong customer demand. We are seeing primarily in associated gas basins, such as the Permian.
Of note, we have raised approximately $55 million. So far this year through non strategic equipment sales to support this newbuild investment program.
Maintenance Capex for the third quarter was $24 million compared to $27 million during the second quarter.
Meg ready and overhaul Capex was down sequentially.
We exited the quarter with total debt of $1 $6 billion in variable rate debt continues to represent approximately 20% of our total long term debt.
In addition, we maintained strong available liquidity of 430 $439 million.
We reduced our leverage ratio to three eight times down from four three times in the third quarter of 2022.
Achieving a leverage ratio of less than four times has been our goal since before I joined Archrock and we are excited to deliver this important company milestone during the quarter.
We have more progress to make and believe it is prudent to move the goalpost, even further particularly in a high interest rate environment.
As Brad mentioned, we currently anticipate taking our leverage ratio lower in 2024 to a range of three to three five times.
We recently declared a third quarter dividend of $15 <unk> per share or <unk> 62 on an annualized basis. This is consistent with second quarter levels and up 7% year over year.
Our latest dividend represents a solid yield of nearly 5% based on yesterday's closing price.
Cash available for dividend for the third quarter of 2023 totaled $63 million, leading to impressive quarterly dividend coverage of two six times.
In addition to increasing the dividend this quarter, we repurchased approximately 354000 shares for $4 4 million at an average price of $12 49 per share.
This leaves approximately $43 $5 million and remaining capacity for additional share repurchases.
Turning to our outlook, we continue to see great execution year to date compared to our plan and we have great confidence in and the compression market fundamentals, our ability to execute and our financial flexibility.
Looking at adjusted EBITDA guidance, we expect to come in close to the high end of our most recent guidance range of $430 million to $450 million.
This implies relatively flat adjusted EBITDA in the fourth quarter, which reflects continued strength in our contract operations segment offset by seasonal weakness in our Ams business and approximately $3 million third quarter asset sale gains that are not expected to recur.
Turning to capital on a full year basis, we continue to expect total 2023 capital expenditures to be around $295 million.
Of that we are holding the line on growth capex of $200 million.
Primarily for Newbuild horsepower to meet key customer demand.
In summary, we are focused on finishing the year on a high note and are planning for an even better 2020 for this.
This includes our expectation for enhanced profitability and improved financial returns and positive free cash flow, while remaining committed to our differentiated capital allocation framework with shareholder return at the top of the list we.
We hope you will join us for what we believe will be an exciting and rewarding rewarding ride.
I will now turn it back the call back over to <unk> for question and answers.
Great. Thank you if you would like to ask a question. Please press star followed by one on your today. Thank you Pat.
Police retract your question. Please press star followed by Kate.
On the time to ask a question. Please NGL thanks, Amit locally.
And our first question, Jim Rollyson of Raymond James Kim. Please go ahead. Your line is open.
Good morning, guys. Congrats on another great impressive quarter moving forward.
Brad just maybe as we think about growth going forward obviously.
Probably getting closer to maxing out on utilization.
And as you mentioned, so incremental horsepower adds which youre going to spend $160 million next year.
Part of that equation and the rest of the equation seems like from a topline perspective will be.
Youre pricing moves from here and Thats been a pretty steady trend upward I'm trying to understand maybe as you sit today and look across the portfolio of the fleet at your most recent contracts and the implied pricing.
Some of your maybe older contracts that haven't repriced.
Moved up with the inflator basis trying to understand the spread there to kind of figure out how much upside room. There is just from today's market.
Mark your fleet to the market today.
Thanks, Jim.
Believe there is substantial upside in the profitability to the business and when you think about profits you sited.
Two of the three items that will continue to move the needle for our performance. The first is incremental horsepower growth as we grow our fleet responsibly with great investments at.
Very solid returns for our investors.
One the <unk> and I'll come to pricing third one that you missed is we remain ambitious about managing our costs with the investments we've made in technology to improve the performance of our fleet. We believe it's also going to enhance the profitability of our fleet. We believe that that is an investment that's going to yield <unk>.
Mental improvements in returns for years to come we intend to exploit that aggressively.
In 2024, just as we have in 2023, but also in 2024 and beyond.
And then finally on pricing, we certainly have room to bring the installed base up to a more current spot pricing over time, and we're ambitious about what we can deal with those pricing moves. So we believe these are three solid levers that are going to be available for us to drive returns for our investors.
In this market.
Understood I didn't Miss cost I was going to be my next question.
Yes.
Anything.
Sounds like.
There are still levers to pull to improve that side. So.
Historically speaking and it seems like a different time than most of history at least as far as I've been following this space.
With pricing trajectory you have today and obviously the momentum behind it.
And where your costs are today with more things you just kind of alluded to improving that potentially going forward, where do you think margins can go.
We're kind of back in the historical peaks or pretty close to that and I'm just curious.
64 ish percent margin can that continue to kind of inch higher over the next few quarters or how do you think about that.
We believe the investments we've made in the market we have.
Ahead of us.
Port a very sustained margin level like we are experiencing currently.
And an ambitious that we can move margins higher stepping back and looking at the historic returns in the compression space and candidly in the energy space overall.
Returns have to go up when.
When you step back and look at the cost factors to our business acquisition of equipment those costs are up.
Labor costs are up.
Loop lube oil is up.
<unk> pricing is up and we have to improve the profitability of the business to catch up with US returns and then exceeded because very critically cost of capital is up.
And then in our space with extreme capital discipline, right now to attract capital and to deliver returns that attracts capital. Our returns have to go up. So we believe there is room in the energy industry and certainly in compression to continue to prove to improve profitability to accomplish those improved returns.
Makes perfect sense and then just one last question.
With leverage kind of already getting to your original in the range of your original year end goal and obviously next year.
And the envelope down to three to three five times once you get to that leverage level that youre looking for.
Then because thats, obviously consuming some of your your cash flow to get your leverage where you want it to be and your dividend coverage is two six times and seemingly growing.
Kind of curious how you think about allocating capital beyond 2024, when you get your leverage where you want it to be.
We are a returns focused investor we're going to look to return and invest our cash where we're going to yield. The best return that includes increasing the dividends for the benefit of our investors that includes looking at share repurchases for the benefit of our investors.
And with the manage the liquidity and the objective of maintaining a free cash flow objective.
Through the cycle and year over year.
As we grow that cash flow, we will have more to invest in the market. If the returns on the equipment or there also.
Great. Thanks again guys.
Thanks, Jim.
Thank you. Our next question does he Steve Serviceability of today, Steve. Please go ahead. Your line is open.
Hi afternoon, Brad Doug I appreciate all the color on the call.
Feel like I, probably asked this last quarter, but worth asking again utilization rates now a new record didn't seem like it could go higher just a question as we get into our seasonally higher demand area and Im sure Youre asset turnover has to be at near.
Near record lows.
Is it safe to say that utilization is sustainable because youre not going to be returning.
Compression into the winter months.
Fair way to look at it.
Yes. It is.
What we said in the past I can say again and that is that there is not enough compression market at compression equipment in the market today to meet current production needs not to mention the growing production that we see coming from the expansion of LNG exports.
So we see high utilization rates continuing.
We see incremental growth ahead to support that level of production.
So we think utilization can maintain and candidly can even continue to tighten from here based.
Based on the.
The demand we see in the market today.
Okay.
And I think I know the answer to this but I'll ask it anyway, obviously in more drilling related sectors, we've seen smaller operators getting more aggressive pricing.
And pushing down margins clearly the numbers show it is not happening here any pressure from smaller operators or is everybody.
Previous answer operating at such full capacity.
That's just not at any kind of a near term risk.
There is definitely pricing competitiveness in the marketplace.
That we experience.
But with a high quality group of customers, we have that are looking at growth and and the need to expand their compression operations.
I understand and with the inflation that we've experienced in the past the market has been digesting and understanding of the rate increases that we've put in place to date, we've had a good level of accomplishment and our overall rate book. So it's not that there's not competition there is.
But it's that with the growth in the market and recovery from inflation and the need to improve returns the pricing that we've accomplished in the pricing that we expect to continue to drive in 2024, we believe will be accepted by the market to boost those returns.
Okay.
Steve if I could just emphasize a portion of brad's answer there right. If we go back to end of 2019 end of 2020 I think we said this on our last call we've seen nearly.
A 40% increase.
And the cost of new build large horsepower equipment from something in the $900 a horsepower to approaching $200 a horsepower.
That increment means that.
Customers that are ordering their own equipment with the four side of doing so again with long lead times for that equipment.
A potential new entrant, which which we havent yet seen or anyone else in order to get any kind of a recovery is going to have to be pricing. It at what we see as current rates and so.
Again, I think one of the really attractive parts of the Archrock story is.
<unk> three <unk> six.
637 million horsepower installed base that in a large and a lot of cases was acquired at a much different timeframe.
We think that continues to attract a higher price and.
And as Brad talked about that upside for 'twenty four and beyond.
I think the likelihood of somebody coming in and cutting price just would be destroying value are destroying capital.
That's helpful. Thank you if I could just get one last one in just on maintenance Capex came down this quarter is there much idle capacity left to make ready or what would you expect trends being said youre going to have to maintain a larger fleet going forward theoretically into next year.
We still have about 100000 horsepower that could be made ready and go to work over the right timeframe.
But we will not and we do not expect to have the same level of make ready expense flowing through.
The maintenance Capex that we experienced in the first half of 2023.
Great. Thanks, Brad Thanks, Doug.
Thank you.
Thank you as a reminder, if you would like to ask a question. Please press star followed by one on your telephone keypad.
And our next question does he Selman.
Stifel Feldman. Please go ahead your line is open.
Thank you good afternoon and good morning.
So let me just start with in terms of spot pricing.
You were to characterize it versus.
Six nine months ago, how has that trended.
Up.
Yeah.
Now, let me expand on that a bit.
We find that we are in a very aggressive pricing posture now for reasons, we've already discussed on the call. So I won't go into all of them Selman.
But just catching up with original equipment cost for new builds to catching up with parts and labor.
And the fact that cost of capital has increased.
As justified significant amount of price reclamation in the energy space and compression that we and you can see it in our competitors also are benefiting from.
Do not see the ability to raise prices changing or abating, the slope of the curve start to flatten a bit but we still are very positive that we can see more pricing gains.
From our installed base in 2024.
And that's still ahead of us.
And by the way, let me expand on one point.
On required.
I wanted to expand on one point, which is that.
One of the really interesting aspects of this high inflation that we just went through that as yet not fully appreciated and you can see it in the pricing and returns that we're going to achieve in the future.
As the value of our investments that we made ahead of this inflationary period.
<unk> of our fleet has gone up substantially and we expect to clean.
Clean improved returns off of those great investments that we've made before this high inflation environment kicked in.
Yeah.
Understood and then if I think about.
How much of your fleet is left to reprice.
How would you say that.
We estimate that still.
Two thirds of our fleet can be repriced over the next 12 months.
Part of that comes in the form of.
Units that roll off term.
Part of it comes in the form of units that are under a major strategic alliance with our customer base and has pricing mechanisms in there some of which are indexed and some of which are just negotiated so but that allows us to keep the pricing fresh on our fleets and it's about two thirds that will be repriced.
For the next 12 months.
Understood.
So this.
This is ultimately where I wanted to get to.
How.
Yes with your.
With your focus on costs.
How does your gross margin not keep from expanding from here.
We are very ambitious about our ability to continue to improve our gross margin and the profitability of our business based upon both factors price increases that we expect our ahead as well as cost opportunities that we are attacking vigorously.
The company.
Yes.
I'll, just I think well well, we're not we're definitely not going to give you a 2024 guidance today.
Because we are still in the process of putting that plan together.
But look I think we've said eight consecutive quarters of sequential revenue growth.
From where we sit today from from the conversations we're having with our customers. We certainly expect that streak to continue and.
You've got to you've got to let us leave us something exciting to talk to you about when we report Q4 early next year.
Okay.
Wanted to just pivot over to the balance sheet and some comments you made there.
You talked about your goal of getting down to three three and a half and you talked also about wise thing to do in higher interest rate environment.
Complete agreement there, Matt I guess my question is and I am thinking about interest expense.
Even with lower leverage unless you actually take your debt levels down.
Your interest expense would be would it be so in order to lower that or are you guys planning on paying down additional.
Debt or do you typically are you seeing your leverage just being achieved through higher EBITDA.
So a couple of comments there.
And I think you were you coined a phrase that I've now use since then when we were at last out on the road with your settlement.
Yes.
Sure.
We're not just planning to take leverage down as you called it the Texas way by growing EBITDA right, but.
We've actually repaid $230 million or so worth of debt since 2019.
And that has been a meaningful.
Part of the leverage reduction so yes, as we look forward and think about EBITDA growth into next year and the use of free cash flow.
Thereafter, we have said that.
The three things that we'll look at there are new growth Capex expenditures.
Increasing our dividend.
And then leverage reduction <unk> share buybacks right and so we will continue to evaluate all of those and.
Again, I think when comparing us certainly to other midstream companies and definitely to the rest of the compression peers.
Best in class provider, there, we have flexibility that some of our peers don't have and.
We will look to find the right balance of all of those different possibilities of what to do with free cash flow.
Understood.
And then I guess you mentioned conversations on 2025 are starting.
Just how are those going.
And.
Okay.
Curious, meaning they're very open to seeing continued price increases out that far still hearing things are going to be tight is there just any insight.
Insight you can kind of give on.
What's going on there.
Demand is high for 2020 for.
Demand signals overall pricing and horsepower.
Amounts in unit amounts those discussions with customers.
Our strong at the beginning of 'twenty four as they were in 2023.
And in fact, I think in some cases, they are earlier because with the tightness of the market our customers.
Have become accustomed to planning further in advance than they ever have.
It's it's a robust market.
And it looks to be very demands and growth oriented continuing through 2024.
Alright, Thank you very much keep up the good work.
Thanks.
Thank you we have no further questions I'll now hand back to Mr. Jones for any final remarks.
Thank you everyone for joining our fourth quarter call. This morning are performance was exceptional this quarter and with Archrock enhanced platform and financial flexibility, we are well positioned to capture opportunities presented by the current market.
I look forward to updating you on our progress next quarter. Thank you everyone.
Thank you. This now concludes today's call. Thank you all for joining you may now disconnect your lines.
[music].
Okay.