We recently researched APA Group (ASX:APA) in The Dynamic Investor. APA shares have weakened back of several factors. These include: i) An unfavourable draft regulatory outcome on one of its assets, ii) Higher US treasury yields which have pressured valuation and ii) Ongoing market concerns about the Company’s ability to fund its CAPEX program.

APA is a stock that investors buy for the dividend. However, despite its near 8 per cent yield per year, the share price is down about 45 per cent in two and a half years. Accordingly, we consider whether these fundamental factors noted above are now reflected in the share price and we have finally seen the lows, or does APA remain a value trap?

About APA Group

APA Group is the largest owner of natural gas transmission in Australia. Its major segments are East Coast Gas (ECG), West Coast Gas (WCG), and Electricity Transmission. Its ECG business contracts with the energy retailers and provides transmission from gas production fields to major cities. The WCG business is oriented towards gold mining.

Key Fundamental Drivers

Mixed Impact from Regulatory Decisions

In early December 2024, The Australian Energy Regulator (AER) confirmed its recent draft decision not to make a scheme pipeline determination for the South-West Queensland Pipeline (SWQP). This meant that the SWQP will remain a non-scheme pipeline and subject to light regulation.

In the same month, the AER released a draft decision not to convert Basslink into a regulated Transmission Network Service Provider (TNSP). The AER’s decision follows APA’s application in September 2023 to convert Basslink from a contracted Market Network Service Provider (MNSP) into a regulated asset. (Basslink is a 370km electricity transmission asset that includes a 290km long subsea power cable section. It connects the 220kV Tasmanian transmission network at George Town Substation with the 500kV Victorian transmission network at Loy Yang Substation.)

In context, Basslink generated $51m or ~2.5% of APA’s EBITDA in FY24, supported by the revenue contract with Hydro Tasmania. While Basslink itself is a small contributor to group EBITDA, the broader context is that:

i. It is estimated that Basslink would have delivered ~$75-$80m in EBITDA as a regulated asset (albeit uncertainty from unknown initial regulatory settings including RAB).

ii. Basslink is the 3rd material APA growth investment that is not delivering the earnings we expected when the initial investment decision was made.

If the AER’s final decision (due in the 1st quarter of this calendar year) confirms the draft decision, APA will progress its plan to trade Basslink as a non-contracted MNSP. Thereafter, if the draft decision is finalised, the Company will seek to maximise value of the Basslink asset by trading Basslink’s capacity in the spot market. It also implies that APA will increase charges for the use of Basslink ahead of any competitive threat from the proposed Marinus Link. (The Marinus Link is a proposed undersea and underground electricity and data interconnector between North West Tasmania and the Latrobe Valley in Victoria. The Marinus Link will be built in two 750MW stages, from 2026, with a Final Investment Decision on Stage 1 planned for May 2025).

The Company needs to get most of its recovery of Basslink prior to the opening of the Marinus Link (suggested timeline is 2030). However, given that Marinus Link may run late (as transmission projects typically do), then the earnings period may be extended.

Further Clarity on Expansion Plans Needed

There is market uncertainty regarding the East Coast Grid expansion, given the incremental earnings uplift is not obvious from disclosures provided by APA.

APA aimed for the planned South-West Queensland Pipeline (SWQP) and Moomba Sydney Pipeline (MSP) staged capacity increases from Queensland/Moomba to southern states (TJ/day), to be developed and online in time for the 2027 peak winter period. However, the Company decided not to proceed with an investment decision on Stage 3 until there was further clarity on whether there will be any regulation changes. With the AER

Confirming its decision not to make a scheme pipeline determination for the SWQP, APA is expected to confirm expansion plans in the coming months. APA may commit up to $600m to expand East Coast Grid capacity by a further 100 TJ/day (Stage 3 and 4) in the near term.

APA has outlined a project pipeline of $1.8b, of which only $0.3-0.4b of the is committed at this stage. As such, the market needs to see progress on this pipeline before buying into APA’s current growth strategy. In context, the benefit from a full commitment of the project pipeline not expected before FY27.

Equity Raising Unlikely Despite Funding Pressure

If the final decision on Basslink is confirmed, there is less earnings certainty post FY25, when the current contract with Hydro Tasmania ends. That earnings uncertainty means reduced leverage against the Basslink asset, absorbing some of the APA balance sheet capacity, at a time it needs more.

APA has a significant growth CAPEX program while maintaining its credit metrics within the range required for APA’s targeted credit ratings. The CAPEX required for targeted projects over the FY26-28 period is likely to be in the vicinity of ~$3.0-3.6b. This range is well ahead of APA’s guidance of $1.3b over FY25-27. In the absence of an equity raising, using debt to fund these additional CAPEX requirements would lower the Company’s Funds From Operations (FFO)/debt ratio to below APA’s target of 9.5%.

Other options include potential asset sales, including non-core assets, which may be a more attractive option than undertaking an equity raising with the share price at ~10-year lows. In particular, APA’s windfarm/solarfarm can be sold at a multiple above the existing trading multiple. We estimate that the portfolio can be sold for ~$1.1b, of which ~50% can be used for debt reduction and the residual used to re-invest in the business (thereby reducing overall CAPEX requirements).

Fundamental View

APA shares are currently trading on a 1-year forward Enterprise Value (EV)/EBITDA multiple of ~10x. The current multiple is also well below the historical range of 11.8-13.3x.

Further details on the planned East Coast grid expansion, as well as US 10-year treasury yields continuing to taper off are likely to present a catalyst for the shares from current levels. This could therefore result in a short-term bounce from current levels.

Charting View

Our previous charting commentary in The Dynamic Investor on 17 December 2024 noted that: “The long-term chart shows that APA is still in a downtrend. Even if the November low ends up being the ultimate low for the stock, it will probably need to trade sideways at the very least before it is ready to head higher again. Ultimately, a break above $8 would be needed for the stock to start looking positive again from a charting point of view.”

With the stock near the November low, we could see it bounce from here in the short-term. However, the long-term downtrend is still in place so more conservative investors will need to wait for that to break first. Right now, the long-term risk still remains to the downside.

 

Michael Gable is managing director of Fairmont Equities.

 

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