WEEKLY STOCK COMMENT: APA GROUP
Roy Davidson, 13 December 2018
APA is Australia’s largest natural gas infrastructure business, delivering approximately half of Australia's annual gas use through its infrastructure. APA has interests in gas transmission infrastructure, gas distribution networks, gas storage facilities, and some generation.
Leveraged to long-term structural growth in Australian gas demand
Australia has an abundance of gas resources. Gas, whether natural or coal seam, continues to be the fastest growing energy source in Australia. In our view, long-term demand for gas in Australia will also be driven by the increased penetration of renewable generation. This will result in a significant requirement for gas fired peaking and storage services to help cope with the intermittency of wind and solar. APA is uniquely positioned to participate in this growing demand, with its pipelines delivering over 50% of all gas used in Australia.
Dividends well covered by cash flows
APA pays its distributions based on its operating cash flow less interest and maintenance capital expenditure (capex). The cash flow generated by the business is more reflective of the company’s operating performance and earnings. As a proportion of free cash flow, APA’s dividend payout ratio is now just over 50%, down from around 70% in recent years. The remainder is invested in growth capex to boost future shareholder returns. Growth capex includes both developments and acquisitions.
Takeover blocked by government
APA recently received an A$11.00 per share takeover proposal from Hong Kong based Cheung Kong Infrastructure, valuing the company at A$11bn. Cheung Kong already owns several assets in Australia including DUET, which it acquired in 2017, and stakes in several electricity and gas distribution networks. The offer price was attractive at a 33% premium to the last traded price and 14.5x EBITDA. However, the deal was blocked by the Australian Government due to concerns over concentration of foreign ownership in critical infrastructure assets. Nonetheless, we see the interest in highlighting the long-term appeal of APA’s assets.
Strong defensive portfolio with distribution growth potential
The long-term outlook for APA remains positive in our view, and we expect the company to continue steadily increasing distributions as it has done over recent years. APA’s internally managed structure, long-dated contracts, and the low maintenance capex requirements of gas transmission assets are all positives.
Risks to APA include:
- regulatory change
- declining aggregate demand
- rising interest rates