APA Group: Uncertain times with unsettled management team

About the author:

Author name:

By Nathan Lead

Job title:

Senior Analyst

Date posted:

25 August 2022, 9:00 AM

Sectors Covered:

Infrastructure, Utilities, Banks

• APA Group (ASX:APA) has high quality earnings, a strong balance sheet, CPI-linked pricing, and mitigants to higher interest rates. However, the FY22 asset performance was not compelling, there is a downward trend in the take-or-pay/contracted % of revenues, we think rising spend growth will become evident in FY23, climate change is a long-term value headwind, and the management team is unsettled.
• HOLD. Forward cash yield 4.9%. Target price (login to view).

Event: Release of FY22 result

FY23 DPS guidance (+3.8% growth) was arguably soft vs market expectations, particularly given APA’s revenue exposure to the spike in domestic and US CPI.

FY22 EBITDA was in-line and Free CF above expectations, albeit underlying adjustments mean results are not as clean as yesteryears. No earnings guidance.

APA published both its 2030 climate commitments (includes renewables investment and $150-170m total spend across FY23-30 on structural abatement capex), and work it has undertaken assessing the EBITDA and NPV impacts on key assets of three climate scenarios (at least 5-15% negative NPV impact).

Analysis

FY22 EBITDA +4% to $1692m was broadly in-line if not mildly below Visible Alpha consensus $1713m and our forecast $1700m. It was a beat of APA’s internal stretch target of $1638m that when set reflected a significant increase in re-contracting exposure and extensive COVID restrictions in force.

Our revised BAU forecasts target 5% pa EBITDA CAGR across FY23-27F.

Continuing business EBITDA growth was +2.8% (excl. Orbost whose sale was completed on 28 July). The revenue benefit of higher CPI was evident in the WGP result (+7.5% increase in tariffs from 1 January) but given timing of domestic tariff escalations we don’t think it has appeared in the remainder of the asset portfolio (or has been masked by weakness in a number of assets).

Revenue growth also suffered from lack of growth projects being commissioned, further offset by corporate cost growth and decline in non-Energy Infrastructure earnings. 

Free CF +20% to $1081m beat our forecast $1009m; APA’s internal stretch target was $996m. As well as the EBITDA growth, Free CF growth was delivered by a decline in sustaining capex (albeit investors may question the exclusion of certain technology spend from the FCF calculation), tax paid, and debt service.

On our revised BAU forecasts we target 3% pa Free CF CAGR across FY23-27F, with the EBITDA growth absorbed by a rebound in tax, surge in sustaining capex (particularly tech. spend), and lift in debt service.

FY23 DPS guidance +3.8% to 55 cps (implies c.4.9% cash yield at current prices) was lighter than market expectations. Investors may have expected the spike in CPI (both domestic and US) to feed directly into DPS growth, while the FY22 Free CF payout of 58% provided upside into APA’s target payout range of 60-70%.

However, APA has set the DPS to deliver consistent growth over time through an uncertain Free CF outlook, and also with an eye to funding significant growth opportunities that may arise over time. We target c.4% DPS CAGR across FY23- 27F, driven by our Free CF growth forecast and mild increase in distribution payout.

Forecast and valuation update

Immaterial change to total forecast EBITDA. Operating CF downgraded because of technology spend, assumed interest capitalisation of Basslink interest revenue, higher assumed cash levels, and timing of tax payments.

We have reduced and altered the profile of sustaining and tech capex, but note the uncertainty here.

DCF-based valuation lifts (login to view), as a result of the forecast changes.

Price catalysts

High CPI. Value accretive deployment of c.$1.5bn debt capacity. Evidence of benefit of improving macro conditions.

Policy intervention that improves long-term gas market fundamentals.

Risks

Macro (commodity prices, Australian and USA inflation/interest rates, AUDUSD).

Domestic gas market and regulatory developments.

Competition for new projects, both from other operators (eg. CKI) and producers (eg. Santos). Capital management. ESG headwinds re: fossil fuel haulage and asset stranding risk.

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