Longtime reader Carol emailed recently to ask about a USA Compression Partners (USAC), a natural gas service stock that is structured as a master limited partnership. USAC stock only recently hit the market in January via a modest n IPO that raised $198 million.
Carol got in early and is now sitting on a 30% profit about six months later, and is wondering whether it’s time to take her money and run. And in most cases after an IPO, I would advise taking at least some of the cash off the table after the initial pop in shares.
But USAC is not your typical IPO — and as such, I think Carol should let it ride and that new investors should consider staking out a position in this pick.
Here’s the boring part: What USA Compression does and how it is involved in the fossil fuel business. In a nutshell, USAC provides compression and transportation services to natural gas companies, primarily shale gas companies involved in fracking. Compression is a crucial step in bringing gas to the market as a viable fuel since compressed natural gas, or CNG, is what gas-powered buses and trains run on, and because CNG is portable (occupying less than 1% of the volume natural gas does in a normal environment) and can burn more cleanly and efficiently.
But here’s the investable angle: As long as America is pumping gas out of shale and as long as there is a demand to use natural gas, USAC will do brisk business. And since it is structured as an MLP, there is a guarantee of big income from USA Compression’s operations.
Shares have popped 30% since the January IPO, and six months in is typically a good time to assess an IPO investment now that the stock has a decent track record and one or two earnings reports under its belt.
But USAC is not your typical IPO.
Consider that the current CEO has been in the business for 30 years and co-founded the company in 1998. Not quite a venture-funded software company like Facebook (FB) or Groupon (GRPN), with a young programmer at the helm who might not understand how to run a company.
Also consider that USAC is a master limited partnership. This is a special class of company that enjoys big tax breaks in exchange for passing the lion’s share of its cash flow back to investors via “distributions,” which essentially are dividends but have different tax ramifications. Most companies that go public do so either to pay off investors or to fund future growth — and that means the cash is not going back to shareholders in the way it is at USA Compression Partners.
In short, USAC is a stable income investment and a long-term play. The fact that it went public in 2013 doesn’t change this.
So while the 30% pop is nice for early investors, keep in mind that there has been only one distribution of 35 cents a share on May 1. That annualizes out to $1.40 a year — or a 6% dividend yield at current prices, even after the run-up!
Here’s where we get to the reason new money should buy: Because that yield is better than what I expect the broader S&P 500 to do in total returns in the second half, especially after recent volatility in the market. If shares flatline and you make 6% during the next 12 months, that’s pretty darn good considering the alternative.
Also consider that longer-term, natural gas is a huge growth area. Yes, there has been a bit of softness in energy thanks to a sluggish economy broadly and a glut of natural gas specifically that has crushed pricing. But nat gas is a cleaner-burning fossil fuel than oil or coal, and worldwide energy demand continues to soar. Furthermore, USAC’s foothold in the shale business is a great place to be since this is where production potential is the highest in the years to come.
There are risks, of course, for USAC. Maybe it’s too frothy or maybe natural gas demand will suffer if there’s a deep global downturn. But the long-term nature of a dividend-rich MLP means you can be patient in USA Compression Partners and ride out any short-term volatility with the bonus of a 6% dividend.
I like this stock a lot on a pullback. If shares dip back under $21 as they did in June, I might add shares myself.
- Read more about USAC … it’s technical and a bit boring, but a great business to be in. (USACPartners.com)
- Could natural gas replace oil-based gasoline as the auto fuel of choice? (WSJ)
- How natural gas helps reduce pollution. (The Energy Collective)
- James Glassman riffs on how investors can tap into a natural gas boom right now. (Kiplinger)
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at email@example.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.