APA Group: 2021 Investor Day

About the author:

Nathan Lead
Author name:
By Nathan Lead
Job title:
Senior Analyst
Date posted:
26 May 2021, 2:30 PM
Sectors Covered:
Infrastructure, Utilities

  • APA Group (ASX:APA) highlighted the significant investment pipeline that it has the capabilities to pursue, enlarged by the expansion of its target universe into electrification opportunities (and remains domestic and USA).
  • We appreciate the greater framework set around the distribution guidance presented today, but think APA’s intention to cease earnings guidance beyond FY21 will reduce the confidence of investors that took comfort from its provision.
  • We make no material change to EBITDA or DPS forecasts; tax and capex spend adjusted given indications provided today. Target Price unchanged (login to view).
  • At current prices, we estimate the stock is trading on a 5.5% cash yield (franking uncertain), 17% potential 12 month return, and c.9% pa IRR on a five year basis.

Investment strategy

APA made no change to its strategy that was refreshed with the 1H21 result in February.

This includes extending its investment targets from its historical universe (gas infrastructure, renewables generation, and firming) into electrification opportunities and next generation energy technologies (e.g. hydrogen).

APA estimates Australia may have >$68bn of investment opportunities to 2040, the USA c.US$2.7tr to 2040, and the hydrogen economy up to US$11tr worldwide to 2050.

We’ve no doubt there will be significant capital required for a decarbonising world; the question is will the potential returns on new investment be sufficiently attractive to offset the earnings decline we expect in the existing asset base (eg. c.30% decline in group EBITDA from WGP initial contract term expiry in FY36).

We back APA to deliver, but it is investment uncertainty.

Distribution framework

APA’s revised framework for setting its DPS is now 60-70% payout of Free Cash Flow (c.62% payout across FY19-20). Free CF is defined as Operating CF less maintenance capex.

The pegging of DPS to Free CF may create increased DPS uncertainty for investors, because:

  • EBITDA and net interest guidance will cease being supplied after FY21
  • Maintenance costs have been increasing and have irregular spikes (eg. $60m Mt Isa power station overhaul in 1H21)
  • APA’s tax profile will likely be highly variable through the first half of this decade

At this stage, we leave our DPS forecasts unchanged, with the payout across FY22-26F averaging 60% and the DPS growing at 2.7% pa CAGR across the period (vs FY21 DPS guidance of 51 cps).

Ceasing EBITDA and net interest guidance beyond FY21

Management believes DPS growth matters most to investors. We think earnings are more important. The EBITDA guidance (and how tight the range typically is) provides comfort to investors as to the low risk nature of APA’s earnings.

Retracting provision of the guidance adds to uncertainty, and as discussed above makes DPS harder to forecast.

Outlook

We expect one day for APA to announce a capital raising to fund an acquisition in the USA. This is not included in our modelling. On a BAU basis, we expect EBITDA to be flat in FY21, and to grow at 3-4% pa CAGR across the following 5 years.

Given tax paid is assumed to lift as available fraction tax losses are utilised, Free CF is expected to grow at about the same CAGR as EBITDA across the period.

Key credit metric FFO: debt continues to improve beyond APA’s 8-9% target range, leaving capacity to fund growth investment or distributions higher than we forecast.

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