CSI Compressco: We Have Lift-Off

Jun. 14, 2019 12:34 PM ETCSI Compressco LP (CCLP)193 Comments

Summary

  • Within a few months, a revised and increased distribution policy should be announced.
  • First quarter backtracked some from the fourth quarter.
  • The next few quarters should report continually stronger results.
  • Increasing profitability of the oil and gas compression business overwhelms diversification attempts.
  • The company appears to benefit from the financial leverage.
  • This idea was discussed in more depth with members of my private investing community, Oil & Gas Value Research. Start your free trial today »

Now the end of that redemption of the preferred is in sight. The units of CSI Compressco (NASDAQ:CCLP) are beginning to rally. The main investment hope is that the continuing good financial news will enable the price rally to continue for a long time to come. Management reported both during the conference call and the quarterly earnings press release that business was booming and was expected to continue to boom for the foreseeable future.

The unit price hit a low when the company finally decided to redeem the preferred shares by using cash that used to go to the shareholders. This definitely reduced the dilution that the preferred share redemption was causing. But the loss of income by a formerly income-oriented investment vehicle caused a massive market stampede to the exit.

First Quarter Breather

The first quarter results were weaker than the fourth quarter 2018 results. That was expected and was a part of management guidance. Order activity slowed and the results in general backed off from the fourth quarter pace.

The units appear to have taken this minor slowdown in stride. Mr. Market already appears to be looking towards a stronger second quarter. Management also hints that they are reviewing a new distribution policy. That new policy may be necessary as the current rapid growth rate of the recovery needs a fair amount of cash for the partnership to properly service increasing customer demands. The last thing that any business needs is angry customers. Negative cash flow can be a problem for growing companies as increasing working capital uses more cash than operations generate.

This management is particularly concerned as they made a big bet on the early recovery by leveraging the partnership with $646 million in both secured and unsecured bonds outstanding. As the recovery progressed management was able to obtain an additional asset-based bank line that is used for letters of credit but otherwise remains available.

EBITDA did decline to $26 million from the blistering rate of the fourth quarter. But the decline is expected to be temporary as margins and demand continue to climb. All this bodes very well for investors of variable distribution vehicles. The time to get into a variable distribution vehicle is when the distribution has varied down to the current $.01 per quarter rate. The financial leverage makes this income vehicle speculative. But right now, that leverage bet that management made appears to be paying off handsomely.

Nonetheless, this company cannot afford an aborted recovery. It very much needs a sustained recovery to strengthen the balance sheet. In the meantime, the number of compressors leased is increasing in size at a remarkable rate of growth. The current levels of activity justify optimism through at least year-end.

Where The Money Lies

Companies always tout diversification. Sometimes those diversification attempts do not get real far because one sector is far more profitable than the others.

Source: CSI Compressco December 2018 Investor Presentation

Much of the profit lies in the oil patch. The good news is that those margins continue to widen as the oil patch activity continues. The Permian may have takeaway issues. Apparently, those issues are not enough to decrease the currently strong demand for more compression capacity. The result is that prices continue to rise and margins continue to increase.

Unfortunately, this is the kind of news that completely cancels a diversification strategy. The more the company succeeds in increasing operating margins from the oil and gas industry customers, the more dependent it becomes on that one division. Fortunately, the services division does have a counter-cyclical characteristic to it. But as shown above, that services division does not supply anywhere near the revenue and profits of the primary leasing business. This partnership will therefore likely remain as cyclical as its oil and gas customers. The more the profits goal succeeds, the less the diversification strategy succeeds for the time being. It would probably take a major acquisition to change this scenario.

Source: CSI Compressco December 2018 Investor Presentation

Some of the competition foregoes the cyclical oil and gas exploration customer profits for the more steady but less profitable long-term business. Midstream and gas-powered electrical generating plants would be examples of that longer term and steady type business. The business may generate a lower gross profit margin, but that business is also more suitable for an income vehicle.

That means that this partnership is probably an attractive investment now before income is distributed to partners in any significant amount. Once that distribution becomes generous, then it is essential for income investors to look elsewhere before there is evidence of a cyclical downturn in demand. Leaving a variable distribution entity such as this one is far less dangerous than "overstaying your welcome" and risking a significant unit price drop in the name of maximizing the income distributions.

The Future

The next few quarters are predicted to be stronger than the first quarter. The market already appears to be looking forward to the stronger quarters as well as a distribution increase.

However, this partnership is financially leveraged. It will remain a risky investment until that leverage is properly serviced by cash flow or is paid down to an acceptable level. This management made a big gamble by floating bonds to raise the debt level significantly. That gamble enabled increased participation in the recovery. Now management must make that gamble pay-off by delivering investment grade ratios to investors. It does no one any good if this company crashes (or worse) during the next cyclical downturn.

The competitive strategy ensures that this is not a typical income investment by any means. However, the recovery potential is astounding provided the oil and gas boom continues. Right now, the continuing industry production improvements appear to assure strong demand for the foreseeable future. Even a whiff of market weakness should encourage the most risk-averse investors to abandon this investment.

Management does have balance sheet strengthening as a priority. But management will need a few years to accomplish that goal. A series of low debt acquisitions would jump-start the process if those acquisition opportunities present themselves.

In the meantime, this investment should provide a lot of excitement. Investors with strong stomachs only need apply. Even then the position should probably be a small one so the investor can sleep at night.

I analyze oil and gas companies and related companies like CSI Compressco in my service, Oil & Gas Value Research, where I look for undervalued names in the oil and gas space. I break down everything you need to know about these companies -- the balance sheet, competitive position and development prospects. This article is an example of what I do. But for Oil & Gas Value Research members, they get it first and they get analysis on some companies that is not published on the free site. Interested? Sign up here for a free two-week trial.

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Disclosure: I am/we are long CCLP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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