APA Group: Downgrade to HOLD

About the author:

Author name:

By Nathan Lead

Job title:

Senior Analyst

Date posted:

08 February 2022, 8:00 AM

Sectors Covered:

Infrastructure, Utilities, Banks

• We downgrade from ADD to HOLD, as the share price has risen to be approximately in-line with our 12-month target price.
• No change to 12-month target price of (login to view).
• No changes to forecasts.

Event

We downgrade from ADD to HOLD, given share price strength has reduced potential returns below what we target for an ADD rating.

Analysis

APA’s share price has rebounded past the price it was trading at before it announced a (unsuccessful) bid for AusNet Services in September 2021. The strength of this rebound is somewhat surprising given:

• The strength of the sell-off in response to the AusNet bid, and
• Long-term risk-free rates have increased c.70 bps since that time (albeit CPI expectations have also increased materially).

Forecast and valuation update

We make no changes to forecasts.

APA will release its 1H22 result on 23 February. The 1H22 DPS has already been disclosed at 25 cps, with FY22 DPS guidance of 53 cps (+4% on pcp). We are forecasting c.-1% decline in 1H22 EBITDA, c.3% below consensus due mainly to East Coast Grid re-contracting headwinds and higher corporate costs. Free CF should increase significantly (+18%), due to lower sustaining capex and tax than the pcp.

FY22 is the first year that APA has not provided EBITDA guidance, breaking a long history of providing investors with short-term earnings confidence. However, an estimate of Free CF can be made considering DPS guidance and target 60-70% Free CF payout ratio. For FY22, this implies Free CF growth of -1% to +16% (+7% at the mid-point).

With no change to forecasts, our (login to view) valuation as at December 2022 remains unchanged.

Investment view

The bull case on APA is the scarcity of its long-life asset and contract portfolio (hence making it a potential M&A target), the high quality of its revenues, its high EBITDA margins, the strength of its balance sheet (including fixed rate long-dated debt) and cashflows, and its exposure to the uptick in CPI (particularly benefitting the US$-revenues of the Wallumbilla-Gladstone Pipeline).

Given scarcity of listed infrastructure assets, APA is also potentially a beneficiary of flow of funds from the AST, SKI and SYD takeovers.

The bear case includes organic growth headwinds, revealed willingness to pursue M&A at potentially value destructive prices (and an appetite to buy regulated assets and in North America), rising risk-free rates penalising its long-dated cashflows, and asset life concerns (acknowledged by APA in its 2020 Climate Change Resilience Report and also in its desire to reduce the regulatory depreciation period for its Victorian Transmission System to 25-30 years).

We attempt to capture a number of these factors in our DCF valuation. At current prices, we estimate 12-month potential return of c.6% (including c.5.3% yield) and 5-year IRR of c.6% pa.

Price catalysts

Value accretive deployment of c.$2.8bn of estimated available debt capacity. Evidence of benefit of improving macro conditions.

Strong commodity prices driving expansion by asset owners and thus requiring additional gas infrastructure. Policy intervention that improves long-term gas market fundamentals. Resolution of Orbost plant issues.

Risks

Primary risks are capital deployment (particularly large-scale M&A), asset life (energy transition, ESG, contract life), and macro (real interest rates).

Secondary risks are regulatory, domestic gas demand/supply developments, and noticeably higher (and spikey) sustaining capex.

Find out more

Download full research note

You can find further detailed analysis of company results this reporting season by browsing our reporting season tag, and view a full list of upcoming results on our Reporting Season Calendar.

If you would like access or more information, please contact your adviser or nearest Morgans office.

Need access to our research?

You are also welcome to start a two-week trial of our online platform, which provides access to detailed market analysis and insights, provided by our award-winning research team. 

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.