Calculated Acquisitions And Market Dynamics Propel Energy Firm To New Heights

Key Takeaways

• Investment in quality assets and focus on execution contribute to profitability by enhancing service offerings and operational efficiency.
  
• The acquisition of TOPS with its high-quality assets is expected to significantly boost earnings and shareholder returns.
  
• Archrock's financial stability faces risks from high pricing renegotiations, increased maintenance costs, market demand sensitivity, acquisition integration challenges, and dependence on fluctuating oil and natural gas market conditions.

Catalysts

Operates as an energy infrastructure company in the United States.

• The ongoing investment in high-quality compression assets and the focus on efficient execution are expected to contribute to strong future profitability by enhancing Archrock's service offerings and operational efficiency, positively impacting net margins and earnings.
  
• The affordability and abundance of U.S. natural gas suggest a favorable market environment for Archrock, likely leading to increased demand for their compression services, which could drive revenue growth as the energy sector continues to expand.
  
• The acquisition of TOPS will further enhance Archrock's position in the market by adding 580,000 horsepower of young, high-quality assets, which is expected to be more than 10% accretive to earnings per share and at least 20% accretive to cash available for dividend per share in 2025, positively impacting earnings and shareholder returns.
  
• Maintaining a leverage ratio of 3.2x and delivering meaningful returns to shareholders through dividends indicate sound financial management and operational efficiency, which could contribute to an undervalued stock by providing a foundation for sustained financial health and growth potential.
  
• High utilization rates and the ability to capture additional rate increments due to strong booking activity, especially in the Permian Basin, suggest potential for increased revenue per horsepower and adjusted gross margin percentage, directly impacting revenue and profitability.

Assumptions

• Analysts are assuming Archrock's revenue will grow by 14.5% annually over the next 3 years.
• Analysts assume that profit margins will increase from 13.0% today to 22.8% in 3 years time.
• Analysts expect earnings to reach $360.2 million (and earnings per share of $1.64) by about October 2027, up from $136.8 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 19.1x on those 2027 earnings, down from 26.1x today. This future PE is greater than the current PE for the US Energy Services industry at 17.4x.
• Analysts expect the number of shares outstanding to grow by 7.64% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 8.82%, as per the Simply Wall St company report.

Risks

• High pricing subject to renegotiation with 80% to 90% of the fleet potentially affecting revenue stability if pricing adjustments do not meet expectations or if customer negotiations lead to lower rates.
  
• Increased maintenance CapEx as hinted, though not expected to change annual guidance, could impact net margins if unexpected maintenance needs or costs exceed current projections.
  
• The market cooling and some giveback in dry gas plays, although minimal, highlight sensitivity to market demand fluctuations which can affect asset utilization rates and ultimately revenue.
  
• The acquisition of TOPS, while strategically beneficial, carries integration risks and the potential for unforeseen operational challenges that could impact earnings if the integration does not proceed as smoothly as projected.
  
• Dependence on the oil and natural gas market conditions, particularly in liquid-rich plays and the Permian Basin, poses a risk to earnings volatility due to potential changes in market dynamics or regulations impacting demand for natural gas production and compression services.

Valuation

• The analysts have a consensus price target of $24.38 for Archrock based on their expectations of its future earnings growth, profit margins and other risk factors.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $1.6 billion, earnings will come to $360.2 million, and it would be trading on a PE ratio of 19.1x, assuming you use a discount rate of 8.8%.
• Given the current share price of $20.3, the analyst's price target of $24.38 is 16.7% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.