APA Group: Investment considerations

About the author:

Nathan Lead
Author name:
By Nathan Lead
Job title:
Senior Analyst
Date posted:
24 November 2021, 8:00 AM
Sectors Covered:
Infrastructure, Utilities

  • APA Group’s (ASX:APA) share price has rebounded strongly after it was beaten to the acquisition of AusNet Services (ASX:AST), reflecting the market’s relief that the transaction did not proceed.
  • We upgrade from HOLD to ADD, with CPI tailwinds outpacing organic headwinds.

Analysis

Implications of failed AST bid: In our previous research note we estimated APA needed to bridge a >$3bn gap in order for the acquisition to have zero value per share impact. This willingness to pay overs to diversify into electrification may signal that APA is concerned about the long-term prospects for its existing business (as hinted here); to reflect this, our 2049 terminal value now assumes mildly declining perpetuity cashflows. Alternatively, APA’s penchant for M&A could see its cost of equity rise as it is viewed by the market as cum-capital raising.

CPI tailwinds: APA’s revenues have CPI linkage through contracted price escalations. The low inflation environment has reduced APA’s earnings growth in recent years. However, APA should benefit from a CPI surge in 2022. c.32% of EBITDA is sourced from the Walllumbilla-Gladstone Pipeline, whose US$ revenues escalate annually on 1 January based on November CPI in the USA.

The best indicator for Nov-21 CPI is the Oct-21 CPI of 6.2% YoY. Furthermore, we understand domestic CPI for the December quarter drives annual escalation of a mass of A$ contract revenues in 2022 (and the September quarter CPI was a solid 3%). Long-term we assume Australian and USA CPI averages 2.4% and 3% pa through to 2030 respectively, as per market implied expectations in yield curves.

Interest rate risk: Higher bond rates may impact discount rates but shouldn’t affect APA’s short-medium term borrowing costs. APA’s debt portfolio is fully fixed rate with an average term to maturity of 7.4 years (next major maturity in FY25).

Organic headwinds: High domestic prices can destroy gas demand, evidenced by Incitec Pivot’s closure of its Gibson Island plant. The VTS’ CY22 tariff variation will likely have a negative revenue impact. Furthermore, we expect the macro environment to put downward pressure on upcoming RBP and VTS regulated tariff resets.

In NSW, our confidence of a strong recovery from the drop in contracted capacity seen in 2H21 has reduced, with the Port Kembla Energy Terminal (construction underway, connects into the competing EGP) allowing AEMO to be less concerned about winter 2023 supply scarcity risks. Revenue risk is also heightened by the shortening contract terms upon re-contracting.

Stalking Basslink: APA has rekindled its pursuit of the troubled Basslink asset via purchase of $99m of the asset’s $625m amortising debt at an undisclosed discount. If APA acquires the business, its strategy is to convert it into a regulated asset, with the greatest economic risk being the determination of the asset’s initial Regulated Asset Base by the AER. Basslink is not factored into our modelling.

Forecast and valuation update

Forecast changes at a group level are minor. Compositionally, we downgrade domestic-focused assets and upgrade WGP earnings. Across FY22-26F, we forecast EBITDA/OpCF/DPS growth of c.4%/5%/3% pa CAGR.

We forecast EBITDA below Visible Alpha consensus for FY22-23 and above thereafter. We think consensus is underestimating the CPI tailwind but is too bullish on steady state Orbost earnings and corporate costs. We are below consensus DPS estimates, with tax payable a major uncertainty to free cashflow.

Our previous target price was risked for the AST takeover. We revert to a business-as-usual approach, with a DCF-based target price of (login to view).

Investment view

Upgrade from HOLD to ADD. At current prices, we estimate a 12-month and five-year potential return of c.11% and 7.6% pa, respectively.

Price catalysts

Value accretive deployment of c.$3bn of estimated available debt capacity. Evidence of benefit of improving macro conditions. Policy intervention that improves long-term gas market fundamentals. Resolution of Orbost plant issues.

Risks

Macro (commodity prices, Australian and USA inflation/interest rates, AUDUSD). Domestic gas demand/supply and regulatory developments. Capital management. ESG headwinds / long-term asset stranding.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.


Solid top-line outcome: BAP’s 1Q22 revenue was flat on the pcp, an extremely resilient result given the extent of lockdowns in the period (~70% of stores impacted) and the strength of the pcp (cycling 27% growth). Composition comprised: Trade +2%; NZ -10%; Retail -12%; and Specialist Wholesale +7%. Overall, BAP stated that non-lockdown areas are outperforming expectations. ▪ 1Q22 trade & retail: Trade/Burson revenue was up +2% on the pcp (LFL sales - 1%; cycling 8% pcp); NZ/BNT revenue was down -10% (LFL sales -15%; cycling +4%); and Retail/Autobarn revenue was down -12% (LFL sales -16%; cycling +36%). Within the Retail segment, online sales were +80% on the pcp. Stores percentages impacted by lockdown were: Trade 70%; NZ 100%; and Retail 50%. ▪ Specialist segment results: Specialist wholesale revenue is up 7% on pcp, with Auto electrical/Truckline divisions ‘performing strongly’; and WANO underperforming. ▪ GM pressure expected to be temporary: BAP stated GM was stable across Wholesale and NZ (45% of FY21 revenue); and down ~50bps Trade and Retail (~55% of FY21 revenue), driven by promotional and online pricing in lockdown areas (we assume no margin pressure witnessed in non-lockdown areas). BAP expect margins to revert once lockdowns ease. ▪ The cost base has increased vs pcp, a function of duplicated DC costs (commencement of new VIC DC), and higher group and team member support (covid related) costs. BAP noted FY22 store rollouts and refurbs are on track.

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