Archrock: Strong Q3 Results With 4.5% Dividend Yield, Is It Worth It? (NYSE:AROC)

Investment Thesis

Archrock (NYSE:AROC) is an American energy infrastructure solutions provider with its headquarters in Houston, Texas. This thesis is primarily based on the company’s performance in the recent Q3 results and its future growth prospects. I will also be discussing its dividend payout and yield, along with its valuation. I believe AROC is on a significant growth track with improving gross and net profit margins, but its valuation doesn’t instill much confidence in me at current price levels, and hence, I assign a hold rating for AROC.

Company Overview

AROC is a leading provider of natural gas contract compression services in the United States. The company operates in the midstream sector of the gas and oil industry, offering a range of services related to the compression of natural gas. Its core business involves providing compression equipment and services to help clients transport natural gas through pipelines. Compression is crucial in maintaining the pressure necessary for the safe transportation of natural gas over long distances. The company offers a variety of compression equipment, including wellhead and gathering compressors, as well as processing units. In addition to providing compression equipment, it offers a range of services, including equipment monitoring, maintenance, and other technical support to complement its natural gas compression systems.

4.5% Dividend Yield

AROC has been consistently paying dividends, Q3 FY23 marking its 39th month of consecutive dividend payout. On 26th October, it declared a quarterly dividend of $0.155, bringing the forward FY23 dividend payout to $0.62. This brings its annual dividend yield to 4.5% at the current price level of $13.76. The company is aiming to increase its dividend payout by 5% to reach $0.65 in FY24. I believe AROC has been consistent in its dividend payouts, and we can see a gradual increase in the payouts over the past five years. However, there is no significant growth expected in the coming years, with estimated dividend payout growth in the lower single-digit y-o-y.

Q3 FY23 Results

AROC reported solid quarterly, beating the market EPS estimate by 5%. The revenue was largely in line with the market expectation. I believe the contract operations proved to be the outperformer, experiencing a 22% y-o-y growth. The company managed to expand its operating and net profit margins while maintaining its revenue growth, which is a good sign given the global economic slowdown that we are witnessing.

The total revenue stood at $253.3 million, up 18.5% compared to $213.6 million compared to the same quarter last year. The revenue growth was led by revenue from contract operations at $207.5 million, up a significant 21.7% compared to the corresponding quarter last year. As per my analysis, the utilization maximization fueled this revenue growth. The company improved its facility utilization from 89% to 96% on a y-o-y basis. The strong gas exploration industry demand for compression tools also boosted the revenues. The demand from the oil and gas industry is expected to remain strong given the increasing demand for energy from European countries, especially the Russia-Ukraine war. AROC reported net income of $30.8 million, a massive 100% increase from $13.4 million in Q3 FY22. I believe the company managed to cut its administrative expenses, but this was offset by increased interest expenses. The net margins improved to 12.15% from 7.16%. The EPS quarter for the quarter saw an increase of 100% from $0.10 to $0.20 y-o-y.

Now, let us have a look at the company’s balance sheet. It reported cash and cash equivalent of $482 thousand against the long-term debt of $1.6 billion. I believe this is a serious cause of concern for the company as it’s putting significant stress on the company’s balance sheet, which will affect future fundraising in case it wants to expand its operations. Not only that, but the increasing interest payment as a result of this long-term debt is restricting the company’s interest profit growth. AROC managed to bring down the leverage from 4.3x to 3.8x y-o-y, but I believe the management still needs to address this issue and lower the leverage ratio.

Overall, the company reported strong quarterly results with strong revenue growth and improved profit margins. The management provided FY23 EBITDA guidance in the range of $430-$450 million. I believe the company will achieve this target given the sustained strong demand in the industry.

Valuation

AROC is currently trading at a share price of $13.76, a YTD increase of 57%. It has a market cap of $2.15 billion. AROC is trading at a forward P/E multiple of 20.5x-20x, considering a forward EPS of $0.67-$0.69. The company is trading at a significantly higher valuation compared to the sector median P/E of 10.6x. The consistent revenue and profit growth is the reason behind it trading at such a premium. However, I don’t see much room for significant stock price growth at the current valuation, and I would recommend investors to wait till the stock sees a correction in stock price. Existing shareholders can hold the stock for a 4.5% dividend yield, but making any fresh buying position at the current valuation is not advisable.

Conclusion

The strong demand from the oil and gas industry, coupled with efficient capacity maximization, helped the company grow at a fast and consistent rate. It announced a quarterly dividend of $0.155, bringing the annual dividend yield to 4.5%. The company faces the risk of being overleveraged because of a high long-term debt, which the investors should take into consideration. The company is trading at a premium valuation, leaving less scope for significant stock price growth. Considering all these factors, I assign a hold recommendation for AROC.