APA Group: Incoming inflation kicker

About the author:

Nathan Lead
Author name:
By Nathan Lead
Job title:
Senior Analyst
Date posted:
25 February 2022, 7:00 AM
Sectors Covered:
Infrastructure, Utilities

  • 1H22 EBITDA beat consensus by 2% and Free CF beat our forecast by 4%. FY22 DPS guidance was reaffirmed at 53.0 cps.
  • 12 month target price reduced (login to view), as higher corporate costs and sustaining capex offset the benefit of higher US$ tariff indexation.
  • Given compressed potential returns at current prices, we retain a HOLD.

1H22 key result detail

EBITDA +4% on pcp to $860m beat Visible Alpha consensus $844m and our forecast $816m. What stood out was the earnings benefit from higher output from the Diamantina power station (Qld) and Orbost gas plant (VIC), and higher gas consumption in the VTS. The quality of the beat was moderated by an $11m spike in one-off contributions, as well as a 7% increase in corporate costs.

Free CF increased 23% on pcp to $515m, 4% ahead of our forecast. The EBITDA growth was supported by strong cashflow conversion and lower debt service and tax paid than we expected. Note that sustaining capex spiked again at c.$88m (or $96m including corporate real estate). APA’s FY22 DPS guidance and 60-70% Free CF payout target implies 2H22 Free CF of $378m to $527m vs 2H21 $482m.

Key credit metric FFO:debt of 11.5% had material headroom over the minimum c.9% APA says is required by the rating agencies for its current credit ratings. We think APA has at least $1.5-1.75bn of debt capacity that can be deployed into investment or capital management (constitution being amended to allow for buybacks).

Growth capex $219m was a touch lower than we had expected, but APA says its organic growth pipeline has lifted to $1.4bn across FY22-24 (previously $1.3bn).

APA has secured rights to 100% of Basslink’s debt. Given APA intends converting Basslink into a regulated asset, the setting of the initial DORC asset base will be critical to economic returns. We crudely estimate an asset valuation range of $750m-$1.25bn vs APA buying the debt at a discount to its $624m face value.

APA highlighted it was a beneficiary of rising inflation. Most of the revenue is indexed to inflation (7.5% for the WGP in CY23), it has high EBITDA margins and operating leverage, and its existing debt mitigates rising interest rates (100% fixed rate, 7.4 years average tenor, next major refinancing not due until FY25).

Forecast and valuation update

FY22-24F EBITDA changed by -2% to +3%. Upgrade WGP for higher CY22 tariff increase than expected. Also factor in higher corporate costs and sustaining capex. 

We target FY22 Free Cash of $1,028m, based on +4% growth in EBITDAand lower tax paid and debt service. Over FY23-26F, we forecast 4% pa EBITDA CAGR, driven mainly by stronger CPI (on both domestic and particularly the WGP’s US$ CPI-linked tariffs) and incremental earnings from new investment. 

Operating CF will benefit from falling debt service (refinancing of legacy debt) but be distorted by the tax profile (impacted by the tax benefit of FY21’s liability management and the timing of immediate expensing of commissioned capex and utilisation of available fraction tax losses); we estimate 3% pa CAGR across FY23- 26. Lumpiness in Free CF will also be impacted by spikes in sustaining capex.

Our DCF-based valuation reduces (login to view), because of forecast changes. At this stage we capture the Basslink investment at paid value.

Investment view

At current prices, we retain a HOLD rating.

While APA should deliver mid-5% cash yield over the next 12 months, we don’t see the valuation support at current prices.

Price catalysts

Value accretive deployment of 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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