shhughes1116

For more information about compression, including a good overview of USAC's primary competitor. http://finance.yahoo.com/news/overview-natural-gas-compression-companies-181903522.html

In full disclosure, I should also note that my weighting may be a bit misleading. For reasons I won't expand upon, I am unable to invest in companies that derive more than 10% of their revenues from food, drugs, biologics, medical devices, or tobacco. Therefore my weighting in oil, oil services, and pipeline companies is likely to be higher than others may find prudent.

It is just under 6% of my portfolio. I generally carry about 20-30 positions, so it is currently weighted a bit on the higher end than normal. I guess here is the 10-cent version of my thesis: 1. 85% of revenue is fee-based and generated from compression equipment installed in natural gas midstream applications. This is pretty sticky, and the company states this in their most recent filings. Think of it this way, you can't move natural gas through a gathering system or through a large natural gas trunk line (i.e. WMB's Transco pipeline) without compression. These systems are long lasting, and they need compression for the life of the pipeline. 2. 15% of revenue is fee-based and generated from gas-lift applications for crude wells. After a well is drilled and completed, the crude output declines over time. Producers employ secondary techniques (i.e. gas-lift) and tertiary techniques (water flooding) to improve the output of a well. Assuming oil prices remain low for an extended period of time, the drilling of new wells will likely slow. However, producers will desire to maintain/enhance output from existing wells by using secondary and tertiary recovery techniques. Thus I suspect the use of compression units for gas-lift applications in crude wells will not collapse. 3. Their recent quarter was the first where they achieved a 1.0x distribution coverage. During the previous quarters, the distribution coverage has been under 1.0x, but the controlling shareholders agreed to participate in the DRIP program rather than take distributions. 4. Their cash flow during the recent quarter was a substantial improvement from the previous quarter. However it underestimates their true earning power because a substantial amount of new compression equipment had not been deployed for the entire quarter. 5. They are ordering ~200k in new compression equipment for 2015, all for midstream applications. The drop in crude should not impact new natural gas pipelines current under construction, thus the market will likely be able to absorb the new compression units. 6. Large, addressable market. Compression can be provided by the producer or midstream operator. However, many choose to outsource this work, so there is a large market with more opportunity to expand if desired. 7. Although USAC could operate profitably by itself, I suspect it would make a good acquisition target for one of the major oil service companies.

Added to existing positions in EPD, USAC, and CLMT. 1. In general, I view EPD as fairly protected against the recent collapse in oil prices (with respect to their focus on all hydrocarbons and their very high distribution coverage); 2. I think USAC has been unfairly pummeled by the market given that it derives 85% of their fees from placing their compression units with midstream natural gas projects (and 15% of their fees are associated with compression units on already-producing crude wells); 3. CLMT is a specialty refiner that derives most of their EBITDA from Specialty products (lubricants, waxes, solvents). They have a fairly small business (5%-10%) that sells drilling fluids...that will certainly be impacted, but I think a ~17% share price drop is a bit extreme. More importantly, they are getting ready to ramp up their refinery in ND, and the lower oil/gas prices should encourage more driving, which will result in a higher demand for their specialty lubricants. I have been picking over the carnage in upstream companies, but so far I've avoided putting any money to work in that area. Maybe I am being overly cautious, but I don't think the bottom is in for those companies yet. Moreover, if experiences from the late 80's are any indication, it is likely that there will be a fairly long window in which to pick up beaten-down upstream companies before the crude cycle turns up.

Great opportunity to buy some of the US-based midstream plays (EPD, WMB/WPZ, MMP, NGLS, PAGP/PAA, KMI, SE, to name a few). These guys operate under relatively long-term fee-based contracts that should insulate them from the move down in oil prices, and much of their business is oriented towards natural gas which seems to be relatively unimpacted by the carnage in the oil sector. I also like USA Compression Partners (USAC). They generate income by leasing compression units. ~85% of their compression units are leased to midstream folks over 2-5 year contracts. I see their midstream business as pretty sticky given that most of the newer dry gas and wet gas plays come out of the ground at relatively low pressure...thus compression is necessary to move the gas volumes into the gathering systems and through the midstream system. The other ~15% of their compression units are exposed to crude prices via short-term leases (6 - 12 months) to operators to improve crude recovery rates in existing wells via gas-lift. On the surface, the exposure to crude appears problematic. However, if you dig a bit deeper, you will note that most of this equipment is fungible (i.e. can be removed and installed in other locations), and in most cases it probably makes sense for a driller to continue using gas-lift to extract more oil from an existing well than it does to drill a new well. Current yield is ~11% which probably reflects the fact that this is the first year where they will achieve a 1.0x distribution coverage, along with a fear that the current decline in oil prices will cause operators to discontinue use of gas-lift equipment for existing wells.

I think your last statement is so important. Think of all the young bucks who started their investment careers in late 2008 or early 2009. Although there have been some hiccups along the way, the broadly rising tide following the Great Recession has lifted everyone's boats. Now it seems that everyone thinks they are a great stock picker, although in reality the rising market had more to do with most folks' success. It should be interesting to see what happens when we have a real correction... For what its worth, I also agree with a 5-7 year market cycle for evaluating performance.

Why do you think CFG is significantly better than mediocrity for it to be the best long-term idea today? Something about the management? Business mix? Just curious. Thanks The ten cent version of my thesis is as follows: 1. Around the time of their IPO, CFG was priced at ~0.65 P/B, and ~1.0 P/TB, with a ROE of ~3%. I think the IPO price reflected that the divested entity has a pretty marginal ROE, and had been undermanaged by RBS due to the financial crisis. 2. Royal Bank of Scotland divested only a portion of their stake. They are a forced seller, and the UK government is requiring RBS to divest the remainder of their stake in the next couple of years. Sucks to be a forced seller, but great to be on the other side of the transaction (think the forced divestiture of Voya by ING). 3. As oddballstocks noted, this "production" will take a couple of years to play out, keeping many short-term focused folks out of this equity. 4. I like regional banks. Big enough to achieve some economies of scale, but small enough to enable effective management/oversight. (Value and Opportunity did a pretty good job laying out the bull case for CFG - http://valueandopportunity.com/page/2/) So I look at it this way. The bank is priced for a mediocre ROE. If the divested entity is unable to improve the ROE, then there probably is not much downside. If they are able to improve the ROE to what we would expect from an average regional bank, then they are deserving of a higher valuation. The forced selling over the next couple of years means that end game for this stock (i.e. higher valuation reflective of improved ROE) will take a couple of years to play out. I have a few other ideas which will probably yield higher annualized returns. However, my concept of a "best long-term idea" is not necessarily the idea with the highest annualized return, but instead the idea where the upside is skewed substantially in my favor, and downside is pretty limited, and the risk of substantial permanent capital impairment is very unlikely. I think CFG satisfies these three criteria, and similarly to oddball stocks, my position sizing is a bit larger than some other positions I hold.

CFG. Being divested by Royal Bank of Scotland right now, and currently priced for mediocrity.