Australia | Nov 26 2020
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APA Group will go it alone in the construction of a new gas pipeline in Western Australia's goldfields, having assessed significant demand exists from a range of mineral producers
-Interconnected nature provides for long-term value
-Lack of contracts a key risk
-But manageable given cash funding
By Eva Brocklehurst
APA Group ((APA)) is forging ahead with a long-held ambition for an interconnected Western Australian gas grid. The company plans to construct a new $460m gas pipeline, the Northern Goldfields Interconnect (NGI), that will link the goldfields with the Perth Basin and the Dampier Bunbury Pipeline.
APA does not typically undertake capital projects without a take-or-pay haulage contract, with counterparties also underwriting the return. This is the first time, of which Morgans is aware, that it is proceeding with construction prior to revenue contracts being secured.
APA expects to have an initial 25% of capacity firmly under its belt and long-term contracts in place by the time the pipeline is completed in 2022, and anticipates significant additional demand from a variety of mineral producers.
Providing 80TJ/d of capacity, the new pipeline will be superior to what would be achieved with equivalent expenditure on an expansion of the current goldfields pipeline. It will provide several options from where customers can source their gas.
Morgans considers the interconnected nature of the pipeline provides long-term value beyond the finite life of a pipeline that would be dedicated to a single mine site or power generation investment.
CLSA is concerned the company will shoulder greater risk this time around as there are no contracts as yet, and it is relying on new gold mining projects to support the expansion of the region.
The broker estimates the pipeline could generate operating earnings (EBITDA) of more than $44m, noting APA will fund the build from its $1.2bn cash till. CLSA eases back its longer-term estimated return on investment for similar growth projects.
The fact the pipeline is principally uncontracted poses a risk, Macquarie acknowledges, noting mine development is occurring independent of the availability of gas. Still the project is a positive given its cash funding and will support additional opportunities for growth and expansion in the region. Hence, the broker concludes the risk is relatively small for APA.
Morgans upgrades to Add from Hold, given its calculations of a 10% potential total shareholder return over the next 12 months, and assumes over the next five years APA can grow operating earnings by 3% per annum while its self funding model should mean credit metrics improve.
The broker suspects the company will target completion before June 2022 so as to meet federal criteria for immediate expensing of capital expenditure and envisages valuation will lift over time from both growth in free cash flow and the paying down of debt.
Morgans also notes the company could also announced an acquisition before the results on February although one in the US would require a capital raising. Factoring in the new pipeline contributes to a slight upgrade to estimates, offset by the rise in the Australian dollar which reduces the translation benefit of the Wallumbilla-Gladstone project's US-denominated earnings, interest expense and debt.
Macquarie considers the attractive features of the NGI project are in the opening of a second market for the gas producers in the Perth Basin such as Strike Energy ((STX)) and Empire Energy ((EEG)). The broker assesses the challenge ahead is to expand existing supply contracts and connect new mines to gas.
APA has also indicated it will divest its 50% share of the Mid-cap West Pipeline, which Morgan Stanley estimates has a book value of around $46m and an operating earnings contribution of $5m per annum.
CLSA, not one of the seven stockbrokers monitored daily on the FNArena database, has an Underperform rating and $10.87 target. The database has four Buy ratings and three Hold for APA Group. The consensus target is $11.39, suggesting 6.3% upside to the last share price the dividend yield on FY21 and FY22 forecasts is 4.7% and 4.9%, respectively.
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