Rising Renewables Will Erode Compression Demand While ESG Provides Relief

Key Takeaways

• Increasing shifts toward renewables and tighter regulations threaten long-term growth and margins despite near-term stability from infrastructure needs and ESG initiatives.
  
• Revenue visibility is aided by service contracts and diversification, but customer concentration and exposure to cyclical, asset-heavy markets raise volatility and long-term risk.
  
• High customer concentration, industry shifts to renewables, and reliance on large units expose the company to revenue volatility, margin pressure, and long-term demand risk.

Catalysts

Provides natural gas compression equipment, technology, and services to the energy industry in the United States.

• Although Natural Gas Services Group is positioned to benefit from rising global electrification and the supportive role of natural gas in ensuring energy reliability, the accelerating long-term shift towards renewables and potential advancements in energy storage technology could steadily erode the demand for gas compression equipment, putting pressure on long-term revenue growth.
  
• Despite expansion into lower-emission, ESG-friendly compression solutions that could attract new contracts and support margin improvement, tightening regulatory frameworks and increasing carbon pricing on fossil fuels are likely to drive up operating costs and compress net margins over time, as customers and policymakers push for lower-carbon energy sources.
  
• While the company's recurring revenue from service contracts and its progress in diversifying its customer base provide improved earnings visibility, significant customer concentration remains. The loss or consolidation of large customers could result in abrupt revenue declines, which may further expose NGS's earnings to volatility as the natural gas market evolves.
  
• Although industry trends such as aging North American gas infrastructure and growing outsourcing of compression needs support stable demand in the near-to-medium term, ongoing consolidation among exploration and production clients is likely to intensify pricing pressure, limiting NGS's ability to sustain elevated rental margins as competition increases.
  
• While NGS's strategic efforts to grow through both organic fleet expansion and M&A are supported by a strong balance sheet and access to capital, a large portion of capital expenditures will remain tied to asset-heavy, cyclical markets with limited product diversification-leaving the company exposed to secular declines in natural gas usage and increasing risk to long-term free cash flow and earnings quality.

Natural Gas Services Group Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Natural Gas Services Group compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Natural Gas Services Group's revenue will grow by 11.4% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 10.5% today to 13.4% in 3 years time.
• The bearish analysts expect earnings to reach $29.9 million (and earnings per share of $2.32) by about August 2028, up from $17.0 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 16.4x on those 2028 earnings, down from 18.3x today. This future PE is greater than the current PE for the US Energy Services industry at 12.2x.
• Analysts expect the number of shares outstanding to grow by 0.51% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.53%, as per the Simply Wall St company report.

Natural Gas Services Group Future Earnings Per Share Growth

Risks

• Heavy customer concentration persists, with nearly half of quarterly revenue coming from one customer and a new key account soon accounting for over 10 percent of revenue, making the company vulnerable to contract losses or renegotiations that could drive significant declines in future revenues and earnings.
  
• Secular decarbonization and renewable energy trends may reduce long-term demand for natural gas compression, as accelerating global moves to wind, solar, and battery storage would shrink NGS's addressable market and lower long-term revenue growth prospects.
  
• Margins and asset utilization could face structural pressure from ongoing industry consolidation among oil and gas producers, which strengthens customer bargaining power and may lead to lower pricing and profitability in the coming years.
  
• The company's reliance on fleet expansion and contracted unit deliveries, particularly focused on large horsepower units, leaves it exposed to the risk of cyclical downturns in commodity prices or reductions in customer CapEx, which could drive underutilization, lower rental revenue, and increased depreciation expense.
  
• There is a long-term risk that technological advancements in renewable power and grid-scale storage could erode the role of natural gas as a bridge fuel, potentially leading to lower equipment utilization and stagnant or declining cash flows over time.

Valuation

• The assumed bearish price target for Natural Gas Services Group is $32.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Natural Gas Services Group's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $45.0, and the most bearish reporting a price target of just $32.0.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $223.0 million, earnings will come to $29.9 million, and it would be trading on a PE ratio of 16.4x, assuming you use a discount rate of 8.5%.
• Given the current share price of $24.78, the bearish analyst price target of $32.0 is 22.6% 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.