Bear Of The Day: USA Compression (USAC)

Energy is the only one of the S&P 500’s 11 sectors to generate positive year-to-date returns (since the beginning of 2022), with rapidly recovering demand surpassing what was thought initially to be ample supply (remember the supply glut that caused the unprecedented negative oil prices in April of 2020) and recent pressures from Russian energy sanctions have exacerbated these price pressuring constraints.

Oil & gas enterprises are getting an enormous (but temporary) bid due to elevated near-term profits from global price pressuring supply shortages, and the escalating conflict in Eastern Europe has magnified this effect. Nevertheless, increasingly lucrative energy commodities like oil & gas will inevitably revert to their mean over time, diminishing the recent gains from legacy players.

USA Compression USAC is a leading third-party provider of essential compression services for US oil & gas enterprises (#1 domestic player in natural gas) has been one such beneficiary of the recent updraft in oil prices.

Nevertheless, it may be worth pulling some profits on this high-yielding energy player, who’s returned investors over 70% in capital gains over the last year and a half, along with 30% in cash-flow drying dividends.

USAC’s high-yield investment offering is becoming progressively less attractive every basis point the US 10-Year moves up, which has been reflected in the stock’s recent sideways price action (compared to the rest of rip rallying sector)

The Existential Energy Crisis

Global supply constraints have made US oil & gas products more valuable than ever, but that won’t last forever with the world already making big moves to get rid of big oil.

The existential crisis of mortality that the pandemic (and its lockdowns) induced has society looking towards the health of our planet, with Millennials & Gen Z’s flooding into the public markets since the lockdowns began with a penchant for sustainability.

This next-generation cohort’s market-moving Reddit message board r/WallStreetBets (WSB) demonstrates the level of interest that the next generation of economic leaders has for the flood of new electric vehicle (EV) companies that have hit the public markets in recent years like NIO (NIO), Lordstown (RIDE), Rivian (RIVN), Lucid (LCID), and of course everyone’s favorite EV winner Tesla (TSLA).

This cohort has also had a proclivity for sustainability-focused energy sources like solar with bids for shares of Invesco’s Solar ETF TAN, Enphase ENPH, and SolarEdge SEDG. Uranium stocks like Cameco CCJ, and Energy Fuels UUUU have even seen a revival from their decade-long slump, with younger retail investors flooding into the nuclear space, a key ingredient for achieving our zero-emission goal.

The world is rapidly turning away from fossil fuels, and the energy crisis in Europe has nations looking to achieve energy-independent with the now evident global reliance on Russian oil & gas supplies, highlighting the profit-driving need for sustainable energy.

USAC has finally returned to its pre-pandemic share price levels. Still, I question its ability to maintain this buoyancy with its bottom line at risk of flipping back into negative territory while interest rates soar.

Weak Fundamentals

USAC’s compression services provide energy producers the means to transport their natural gas through the North American pipeline system and utilize specialized compression applications to help in the production of crude.

The company has been unable to turn a sustainable profit despite soaring energy prices in Q4. With mounting debt, declining assets, unreliable cash-flows, and no cash (or equivalents) on the balance sheet, this stock looks like a very high risk/low-reward play at this juncture.

USA Compression’s unwavering $2.10 annual dividend over the past 5 years (maintained with fresh debt during the pandemic) had yield-chasing investors rushing into this double-digit rate with other fixed-income/high-yielding securities looking at reliable returns below 10%.

Every basis point that the US 10-Year yield moves higher, this high-risk energy player looks increasingly less attractive. With this benchmark rate now looking at a 2.3% annual return (highest in almost 3 years), I expect to see investors exit USAC in the weeks to come.

Looking at the charts, you can see that USAC’s excessive dividend kept USAC initially more buoyant than its energy-producing partners (still highly correlated), but since the beginning of 2022, as the US 10-Year yield began its liftoff cycle, favor has quickly turned away from USAC.

Final Thoughts

It looks like it’s about time to pull profits on USAC, as its recent price action starts looking toppy at the pre-pandemic highs it can’t seem to break above. The only thing keeping these shares afloat is WTI crude’s $100+ a barrel price tag.

The expectation of mean-reverting price action in fossil fuels amid this rising rate environment has USAC looks ripe for a sale. Get out while this thing is still in the high teens, with 2 of 3 analysts calling this a conviction sell today (sell ratings are much rarer than buy ratings) while reeling in EPS estimates, and pushing USAC down to a Zacks Rank #5 (Strong Sell).

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