Selman Akyol, Managing Director, Energy & Power, Stifel,
Archrock (NYSE:AROC) is a top pick from the award winning Stifel natural gas midstream securities expert.
Selman Akyol is a Managing Director in the Energy & Power sector at Stifel, covering Energy Infrastructure-MLPs.
He joined the company in 1999. Mr. Akyol’s past accolades include ranking #1 and #2 in earnings estimates for multiple Financial Times/StarMine Awards and The Wall Street Journal’s Best on the Street Survey Awards.
He has been an analyst for more than 30 years, and was previously an analyst at Johnson Research & Capital, a staff accountant at Edison Brothers Stores, and an account executive at PaineWebber.
Mr. Akyol earned an MBA from the University of Missouri-Columbia.
His recommendation for Archrock (NYSE:AROC) is based on fundamentals of the sector and the specifics of the compression specialist.
“Depending on where you look, the year to date as of December 20th or so was about 17%; one year was 20%; and two year was 52%, and of course two years ago you had a very favorable starting point for valuations, given COVID and everything we endured back then, so no surprise that you saw that.
What’s interesting to us is, despite the improvement in prices, we would tell you valuations have not changed significantly.
Currently, looking at it on a market-cap-weighted basis — and this is really across our coverage — you’re trading at about 8.7 times on a forward basis, and that would compare to a six-month average of 8.8, and 8.9 times for 12 months, and a 9 times multiple for 24 months, which is really flat relative to the 36-month and 60-month average.
So, despite improvement in prices, we haven’t really seen improvement in valuations.
Clearly driving that is EBITDA continues to move up over those time periods.
But the other part that’s significant to that is leverage has moved down fairly dramatically, certainly since 2020, with most below the 4 times metric now and best in class in and around the 3s.
As I said, you’ve seen prices improve, you’ve seen valuations be flat, and you’ve seen leverage come down, so we still think midstream infrastructure is a very attractive place to be.”
Archrock (NYSE:AROC) is not the only pick from the Stifel expert but it is the most enthusiastic pick.
“Our picks include Williams (NYSE:WMB). We like Targa (NYSE:TRGP).
We do think that the Street is not focused enough on the compression industry.
We see a longer runway there, and we continue to like the compression segment of the value chain an awful lot. Archrock (NYSE:AROC) is our top pick within that.
We’re seeing bottlenecks on the supply side.
We’re seeing contracts extend; you’re seeing three- to five-year contracting; you’re seeing contracts with inflation adjusters.
The equipment market is very tight, so pricing power continues to accrue to the compression providers, and we think we’ll see that continue and continue to see their revenue metrics ratchet up through 2024. Everyone is already sold out for 2024, so any discussions now are really focused on 2025.
You’re seeing long lead times on critical components — engines, caterpillars, it’s 50 to 60 weeks, which keeps supply in check. And then you also have companies wanting to live within cash flows, which limits the amount of capital they’re willing to invest, so that also helps keep a lid on supply.
So you have continued growth within the Permian, natural gas is certainly a byproduct of the growth in crude oil, and in order to move it, to process it, you need compression, and equipment is very tight in that segment right now.”
Archrock (NYSE:AROC) exemplifies a theme that belongs entirely to this midstream sector.
“A theme that started several years ago and is important to investors is the whole idea of living within cash flows and returning cash to holders.
And so, you’re looking for reconfirmation of that.
You’re looking for capex budgets that will be funded internally.
You’re looking for distribution or dividend growth.
And you’re looking for buybacks.
We see a lot that gets done on the opportunistic side, or characterized as opportunistic.
Our preference would be to see something more with goalposts put in the ground — we intend to acquire so much in X number of dollars, and see that over a multi-year period — as opposed to saying, we will engage in repurchases on an opportunistic basis.
To me, that’s first and foremost in terms of what we’re really looking for: continuation of the financial discipline that we’ve seen within this industry, continuing to have balance sheets maintained and improved, and then return of cash to unitholders or shareholders.”
Underpinning all these values is a rather robust view of the supply and demand for oil in the United States.
Noah Barrett, CFA, is a Research Analyst at Janus Henderson Investors and lead on the firm’s Energy & Utilities Sector Research team.
He was vice president with Institutional Capital LLC specializing in analysis and stock recommendations for the energy and transportation sectors.
He received a degree in economics from Boston College.
He also received an MBA with concentrations in finance, accounting, and economics from the University of Chicago, Booth School of Business.
He also completed the General Course at the London School of Economics.
A recent interview with Mr. Barrett further supports the Archrock (NYSE:AROC) and other midstream oil and gas sector valuations.
“I think one thing when talking about upstream companies, it’s always helpful to start with the macro and a quick overview of what we’re looking at on oil demand and oil supply, because for upstream companies, the price of oil or natural gas is a direct input into their financial statements and ultimately their earnings power and profitability.
So, for oil demand, maybe we can start there.
The outlook for oil demand in 2024 is uncertain.
I would say this isn’t a new dynamic; every year, the outlook for oil demand can be a bit murky.
But I think what’s interesting is that the range of expectations from the various forecasting agencies we look at seems to be wider than usual.
So, on the low end, you have the IEA, they’re expecting 1.1 million barrels a day of oil demand growth in 2024 versus 2023.
They just recently revised that upwards.
So, prior to or a month or two ago, they were even lower.
They were below 1 million barrels a day of oil demand growth.
And then on the high end, you have OPEC, they’re forecasting 2.25 million barrels a day of oil demand growth in 2024.
So looking at the low end and the high end, it’s a pretty big gulf.
If we ended the year at the low end of the range, certainly that would be viewed as a weak demand year.
I think the OPEC outlook seems aggressively optimistic.
But if we were to come in closer to the OPEC number, that would signal that oil demand is to be a lot healthier than expected and would put meaningful upward pressure on prices.
And then the last thing I would say on demand, I think consensus seems to be around demand growth of, call it 1.4 million barrels a day.
I think if we came in at that number, that would be viewed as a pretty healthy market and would be supportive of oil prices at or above current levels.
Switching to the oil supply side, the other half of the equation — this should be easier to model, but there are still a lot of surprises that pop up and change the outlook here.
I think it’s always helpful to break down the components of supply into three buckets.
You have the U.S., you have OPEC, and the rest of the world.
For the U.S., supply growth in 2023 is going to end up over 1 million barrels a day, which was well above expectations at the beginning of 2023.
I think what’s interesting is that if you look at a rig count chart, we’ve seen steady declines in the rig count over the course of 2023.
And that would seemingly suggest that U.S. supply should be falling, not growing.
But there are several factors that explain this interesting phenomenon.
It’s important to consider that the average rig has gotten a lot more efficient at drilling a horizontal well.
So the correlation between the rig count and production has broken down over time.
There is also a timing lag. When you drop a rig, you may not actually see an impact on production for two to three quarters out in the future.
Another factor is the frac spread count, which tracks completion activity. This has been a bit more stable. The rig count reflects wells drilled, but the frac spread count reflects completed wells and ultimately production.
So if the frac spread count has been a bit more stable, that would indicate that we should expect production, all things equal, to be fairly stable and potentially growing as continued production and completion efficiencies flow through the system.
And one last thing that is worth considering is that in 2023, U.S. supply growth was optically boosted by a flip in the DOE adjustment data.
Over the past five years, in our opinion, the DOE was underestimating U.S. supply fairly consistently, by 400,000 to 500,000 barrels a day.
As part of their methodology, there’s typically an adjustment factor in their data.
And in 2023, we saw that adjustment factor flip and it went from positive to negative.
So this doesn’t mean that the U.S. is producing more or less oil in absolute terms, but it does mean that when you’re comparing supply data across periods, there’s distortion in the number.
Putting it all together, what do we think for 2024?
I would expect the pace of U.S. production growth to moderate.
We’ll see some continued efficiency gains, but assuming the rig count and the frac spread count are static at current levels, I think something in the 300,000 to maybe 500,000 barrels a day of year over year supply growth is a reasonable assumption.
Moving over to OPEC supply, their market share has eroded, spare capacity has moved higher, and the bulk of the cuts have been borne by Saudi Arabia.
I do think there’s a valid question over how much they want to continue to prop up the oil price while ceding market share and letting others, particularly the U.S., bring supply into the market.
I don’t think we have any unique insight into Saudi policy, but our view is that they will actively manage supply to keep Brent prices above $70 a barrel, with the full understanding that in the near term, oil prices could drop below $70.
But I think they would like to consistently see Brent oil prices above $70 a barrel.
And so, we feel comfortable with OPEC policy and OPEC cohesion.
And then the last bucket would be non-OPEC, non-U.S. production.
We’ll get some supply additions from Canada, Brazil, and Guyana in 2024.
But these are all well telegraphed and fairly easy to predict.
Putting all the balances together, we have U.S. supply growth of 300,000 to 500,000 barrels a day, maybe 800,000 to 900,000 barrels a day of non-OPEC, non-U.S. supply, that would suggest that if OPEC keeps supply flat, that roughly balances the market.
If we see OPEC take incremental barrels out of the market, that probably puts upward pressure on the oil price.
If they decide to bring some barrels back into the market and try and maintain a certain level of market share, that probably puts some downward pressure on the oil price.
Overall, I think that leads to an expectation that Brent oil prices are range bound in 2024, oscillating between $70 a barrel and $90 a barrel.
And I think we’ll see a lot of volatility within that range.
But that’s our expectation for oil prices.
And ultimately for upstream energy companies, that $70 to $90 a barrel price range is fairly healthy.
I think that’s an OK price for most producers.’
Archrock (NYSE:AROC) as well as other midstream sector companies would seem to be poised to benefit the most from this supply/demand dynamic in 2024. Get all the top picks and more analysis from reading all the interviews in the new Oil & Gas sector report, exclusively in the Wall Street Transcript.
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