EUR 850.00 For Business Accounts Only

Morningstar | Steady FY18 Performance for APA Group; Lifting FVE 2%

APA Group's fiscal 2018 EBITDA increased 3% to AUD 1,518 million, slightly above expectations and guidance. Fiscal 2019 guidance is for EBITDA of AUD 1,550 to 1,575 million, representing growth of 3% at the midpoint. This modest growth comes despite ongoing substantial investment in new projects, highlighting headwinds in existing assets, including lower demand on some pipelines and lower returns for regulated assets. We expect earnings headwinds to continue as gas market rule changes designed to reduce gas transportation costs ramp up. Nonetheless, APA Group remains one of Australia's better-quality infrastructure companies, warranting a narrow economic moat rating.

We marginally upgrade near-term earnings forecasts to line up with guidance, and lift our underlying DCF-based valuation 4% to AUD 8.30. Our fair value estimate increases 2% to AUD 9.65, being the midpoint between our underlying valuation and the takeover offer price of AUD 11, reflecting our estimated 50% chance of success. Currently, APA screens as fairly valued. Distribution guidance, if the takeover doesn't succeed, is for AUD 46.5 cents per security, or cps. This represents a modest 4.6% mostly unfranked yield based on the current security price.

There was no new information on Cheung Kong Infrastructure's takeover offer. Both parties are committed to the deal. The Australian Competition and Consumer Commission will provide its view around competition concerns in mid-September, which might require CKI to sell a few small assets and make other minor concessions. The main risk to the deal falling over is whether the Foreign Investment Review Board, or FIRB, approves of the Hong Kong-based CKI taking ownership and control of APA's strategically important gas transmission grid. The FIRB's decision will come after the ACCC's decision. Should the FIRB block the deal, there is potential for Australian bidders to emerge.

Nonetheless, conservative investors might prefer to lock in gains by selling on market. There are plenty of other good-quality income stocks covered by Morningstar trading at more attractive prices.

Fiscal 2018 net profit after tax came in at AUD 265 million. Operating cash flow rose 4% to AUD 90.7 cps, comfortably covering distributions of AUD 45 cps.

The core business--Energy Infrastructure--reported a 3% increase in EBITDA to AUD 1.5 billion in fiscal 2018, mainly on 4% growth in Queensland, which is APA's largest market by a wide margin. Queensland benefited from the start of a new pipeline for an LNG export customer, as well as favourable U.S. currency and CPI movements, which impact earnings for the large Wallumbilla Gladstone Pipeline. Other key states were mixed, with Victoria and Western Australia up 1.5% and 1.2%, respectively, while New South Wales' earnings fell 1.6%. We expect modest earnings growth to continue for the medium term, as completion of new gas pipelines and renewable energy developments offset headwinds in existing assets. The smaller businesses of Asset Management and Energy Investments were also mixed, with EBITDA increasing 13% to AUD 66 million and falling 5% to AUD 23 million, respectively.

APA's balance sheet is sound. The large equity raise earlier in the year helped gearing fall 200 basis points to 65.4%, where it sits at the bottom of management's 65%-68% target range. Net debt/EBITDA was 6.3 times in fiscal 2018, which is close to the upper limit of what we consider reasonable for highly defensive infrastructure companies like APA. However, we expect credit metrics to improve in coming years as retained cash flows should be sufficient to fund expansion projects. Guidance is for growth capital expenditure of AUD 425 million in fiscal 2019, and AUD 300 to 400 million in the next few years, on top of about AUD 100 million of maintenance capital expenditure each year.

The firm's average interest rate increased marginally to 5.65% but should fall this year after repaying expensive hybrids. Not much debt matures in the next few years, reducing refinancing risk, but what debt there is should be refinanced cheaper as long as credit markets remain sanguine.