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