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Australian Edge: Down Under Digest

By David Dittman on September 5, 2011

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“If it involves gas, there’s a better-than-even chance that it will involve APA.” That’s the straight-up observation of the domestic market offered by APA Group Ltd (ASX: APA, OTC: APAJF) managing director and CEO Mick McCormack during a conference call to discuss his company’s fiscal 2011 (ended Jun. 30) results.

Australia’s leading gas transportation company has interests in almost 12,000 kilometers of natural gas pipeline infrastructure all over the country. It runs more than 2,300 kilometers of gas distribution networks in south east Queensland as well as gas and liquefied natural gas (LNG) storage facilities and gas processing facilities. APA owns and operates assets in each mainland state and territory in a country that never felt the sting of recession that afflicted every other developed nation and most of the emerging world as well. The company has been paying dividends since 2001, and it’s raised its payout consistently for a decade.

The company manages and operates all its assets and also provides management and operation services to companies in its energy investment portfolio, including gas transmission and distribution company Envestra Ltd (ASX: ENV, OTC: EVSRF). The “great bulk” of its annual revenue is secured by long-term contracts with high-credit-quality entities such as government-owned energy generators and regulated returns. That’s an important point to keep in mind on days like these, when the action in global stock markets suggests the end is nigh. Because basically everything it does is underwritten by long-term contracts or regulatory arrangements, it has no commodity-price risk. That’s another key if you need steady, reliable income from your investments.

Over the last four years–a period that includes the integration of a number of assets acquired during the preceding two years and overlaps with some of the worst global economic conditions since the 1930s–APA has grown operating cash flow by 17.8 percent per year. Active on the acquisitions front and aggressively funding organic growth, APA is well-positioned for further expansion as Australia flirts with regulation of carbon dioxide (CO2) emissions and new discoveries of natural gas fields and technological advances that make tight and shale gas more accessible drive demand for infrastructure.

APA is able to maintain its stable yet growing profile because it has good access to capital. It raised AUD300 million in equity capital in late June, the net proceeds of which will cover the fiscal 2012 capital expenditures (CAPEX). It sports investment-grade credit ratings from Standard & Poor’s and Moody’s Investor Services, and it’s been able to refinance AUD1.8 billion over the past four years. Debt-to-debt plus equity was down to 66.2 percent as of Jun. 30 from 70 percent a year ago. Management is working to keep this ratio between 65 and 70 percent. The forecast for fiscal 2012 is 68 percent.

APA backs the first and to date still the only 10-year bond in the Australian medium-term note (MTN) market by a BBB rated issuer, a sign of the support the company has from its domestic investment community. The 7.75 percent coupon was about 265 basis points above the comparable Australian government bond at the time of issue.

APA has AUD900 million of relatively cheap bank debt coming due in June 2012. Management anticipates paying higher interest costs in 2012–between AUD260 million and AUD265 million, up from an above-forecast AUD247 million in fiscal 2011. The company has already successfully rolled over AUD1.8 billion over the past two and a half years, so access to credit won’t be a problem. It won’t be able to get it done at comparable rates, however.

Although it books tax expense on its profit-and-loss statement, APA is still not paying cash taxes; management’s current forecast is that APA will begin paying cash taxes in fiscal 2014. According to management, “The significant excess depreciation over stay-in business CAPEX coupled with the taxation expense provide significant operating cash flow available for distribution and funding growth.”

Management retained AUD100 million after distributions to invest in the business. Efforts are focused on expanding pipeline and distribution capabilities in the eastern half of Australia to boost gas transportation and storage services, while in the western half of the country the emphasis is on growing storage capacity.

Geographic and asset diversity proved once again a factor in APA’s ability to deliver for investors in fiscal 2011, as record flooding in southeastern Australia was offset by strength in Western Australia. Operating cash flow was up 8 percent in fiscal 2011 to AUD290 million, or AUD0.526 per share. A key metric, operating cash flow covered APA’s AUD0.344 per share distribution for fiscal 2011 by a 1.6-to1 ratio; management reported a payout ratio of 65.7 percent.

Regulatory relations are basically OK. There is the looming threat of the CO2 tax–AUD23 per tonne for Australia’s largest polluters–but it’s expected to be neutral for APA Group because of cost-recovery mechanisms built into the regulatory framework and written into its long-term contracts. Management actually looks at the switch from coal- to gas-fired electricity generation is a plus for APA over the long term, given its asset mix.

APA has earned a reputation for consistent dividend growth. So the way it worded its dividend forecast for 2012 caused some consternation among the analysts dialed in to the company’s conference call in late August. That the dividend for fiscal 2012 will be “at least equal to FY2011” signaled to some analysts a change from the past, when APA has consistently grown its distributions.

From fiscal 2010 to 2011, for example, the payout grew 5 percent. Management did not hide from the fact that its guidance has changed. Mr. McCormack took pains to emphasize that this particularly artful use of words does reflect the fact that the company has added significant assets in recent years that will require greater organic growth CAPEX than in recent years. The CEO was equally adamant that an increase consistent with those of the past hasn’t been ruled out. What he also made clear is that the dividend for fiscal 2012 will be at lease AUD0.344 per share.

Like most Australia-based publicly traded companies APA pays a semi-annual dividend, usually declaring in December and June payments for March and September. The March payment is known as the “interim” dividend, September the “final.” The best way to read APA’s dividend history is to compare “interim” payments to “final” payments. Also like most Australia-based dividend-payers, APA’s final payment is slightly greater than the interim.

For example, APA management recently declared a AUD0.179 final dividend for fiscal 2011. In December 2010 it declared an interim payment of AUD0.165 per share. This interim payment was actually lower than the final dividend declared for fiscal 2010, which was AUD0.17 per share. Sequentially, just based on dates and amounts, it looks like a cut; in context it’s entirely normal.

As of Monday’s close–observances of Australian “labour” are set by the various state and territory governments and so vary quite a bit–APA Group was yielding more than 8 percent. At these levels nine of the 13 analysts who cover the stock rate it a “buy.” Three call it a “hold,” while one says “sell.”

Australia, unique among developed economies did not sink into recession after Lehman Brothers’ September 2007 bankruptcy. It boasts a remarkable record of growth since the mid-1990s–Australia has grown at an average annual rate of 3.6 percent for over 15 years, well above the OECD average of 2.5 percent. That’s a compelling piece of the story, but it’s only one piece. We’re attracted to the market because Australia is home to many businesses that are capable of building wealth for investors over the long term. APA Group is just one example.

One of the most important lessons I’ve learned during my time in the investment newsletter business is that we buy businesses, not “the stock market” or “the economy.” That’s a lesson to keep in mind when indexes all over the world are flashing red. It’s important to have a sense of the larger forces at play–an appreciation for the view from 30,000 feet–but investing over the long term is about buying businesses, and that means knowing what’s happening on the ground.

Businesses don’t exist in vacuums, obviously. The best way to evaluate the constant stream of economic data is in terms of how it is or is not or will or will not be reflected in the operating results of the businesses you own. This is a way to manage what can be an overwhelming flow of information.

Australia’s largest gas infrastructure business, in its 11th year as a publicly listed company, APA Group has paid a dividend since March 2001. Experienced management helped the company navigate difficulties such as Queensland’s record floods in 2011. Conservative financial practices and a good mix of fee-generating assets position it well to build wealth for the long term.

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  1. avatar
    Martin Gough Reply December 17, 2012 at 1:02 AM EDT

    I have sent you several emails in the last few weeks regarding my subscription to Australian Edge but have received no reply at all, and I don’t think I have had the newsletter either. Will you kindly let me know if I am still a subscriber , and also to Canadian Edge.

    Martin Gough

  2. avatar
    GORDON JENKINS Reply March 12, 2012 at 3:41 PM EDT

    when I subscribed to Australian Edge the understanding was that information on the “Cloud” would be included in my initial reception of info. Haven’t reeived anything extra at all