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ESG Focus: APA Group Pushes Gas Prospects

ESG Focus | May 10 2022

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APA Group highlights sustainability

APA Group ((APA)) is heavily exposed to brown infrastructure but the company used its investor day to highlight the role of gas as a transition fuel, its green ambitions and ESG credentials in a bid to reassure investors.

-Social and governance metrics highlighted during APA Group's investor day
-Brokers examine decarbonisation prospects
-The race between renewables investment and stranded assets

By Sarah Mills

APA Group’s ((APA)) annual investor day focused on the company's sustainability initiatives – a fear point for investors – and Morgan Stanley and Ord Minnett took the opportunity to examine APA's ESG exposures and reporting progress.

In particular, the company highlighted the important role it believes gas will play in the green transition.

Management Unveils ESG Metrics

Starting with announcements, the company has implemented board-level accountability for climate change, health, safety, environment and heritage issues (including First Nation’s engagement); and has undertaken to provide interim decarbonisation targets at it FY22 result.

Management revealed several ESG metrics – particularly social and governance metrics,

The company reports:

-40% female board and senior management representation;
-50% female graduate/intern/apprentice intake;
-an increase in parenting leave;
-a 65% rise in employee engagement; and
-the company has built in First Nations KPIs into employment and supply chain KPIs in recent construction contracts.

Morgan Stanley notes the company does not yet report on its waste recycling, water usage or net contribution to biodiversity.

It says the company is in the third tertile for gender diversity compared with sector and regional peers, but fails to specify whether that is upper third, or the lower third.

Brokers Examine Decarbonisation Prospects

The company owns and operates Australia’s largest natural gas infrastructure, and other energy infrastructure assets such as gas storage and wind farms.

Morgan Stanley notes that while APA Group derives 95% of earnings (EBITDA) from fossil fuel infrastructure (methane in particular), the company’s future investment is being directed towards the transition (sustainable products currently generate about 4% of earnings).

The company is building stakes in hydrogen, renewables and onshore and offshore electricity transmission and is “highly leveraged to the orderliness (a euphemism of the use of gas as transition fuel) of the energy transition”, notes Morgan Stanley. 

So investors no doubt will be pinning their hopes on the manifestation of said orderliness.

Much will depend on the pace of the transition as well. While gas has been included in the European taxonomy, it was a reluctant admission and, should the investment in renewables accelerate sharply, gas will be one of the first ugly ducklings to be turfed from the nest.

Ord Minnett says management highlighted the important role gas will play in the transition and the company’s ability to leverage these opportunities.

The broker says the company pointed to the UK as an example of a “disorderly” transition where poor gas availability combined with low renewables generation had sharply boosted energy prices for consumers.

APA believes its brown assets (gas pipeline) are well positioned to meet transition demands and to ensure an orderly transmission; and expects its growing suite of renewable power and transmission assets will also serve it well.

Management also aims to link re-contracting and growth opportunities to the transition.

Race Between New Investment And Stranded Assets

This suggests APA Group is embarking on a delicate balancing act, one in which analysts appear to believe it will succeed.

The company is eyeing new energy infrastructure developments in Australia and possibly North America.

Ord Minnett says no information was provided on a potential US acquisition (which the company has been working on for three years) but the company remains confident of finding a suitable prospect and considers valuations to be reasonably attractive compared to Australia.

Morgan Stanley believes the company enjoys a considerable competitive advantage in procurement and approvals.

Add to that, APA Group’s strong free cash flow, solid balance sheet and the large market for energy transition investment, not to mention the willingness of capital to be directed to green investment, and the broker is modestly confident the transition strategy will be sufficient to mitigate the risk of stranded assets and to ensure APA Group can continue to access capital, which is increasingly ESG oriented.

The analyst also considers the commercial benefits of APA Group’s ESG performance are underappreciated. 

Brokers Have Their Say

Meanwhile, Morgan Stanley notes the share prices has rallied 13% this year, which compares with a flat performance for toll roads and airports – the closest peers – and retains an Equal-weight rating (Industry View: Cautious) and $10.00 target price.

The broker appreciates the company’s defensive and diversified earnings base and balance sheet.

The company’s risk-reward profile falls in the middle of the broker’s utilities and infrastructure stock coverage. 

Rising global interest rates remain a risk, as does ESG sentiment, valuation, regulatory changes, shipping recontracting and large corporate activity.

Ord Minnett notes APA management reiterated that 80% to 90% of revenue is linked to the consumer price index, lending strong defensive characteristics in the current market, believing the company’s finances could benefit from rising inflation.

The broker retains a Hold recommendation and $10.50 target price.

All up, in the FNArena database, APA Group is enjoying four Hold ratings with an average target price of $9.925. On forward looking consensus estimates, the shares are currently offering a dividend yield of 4.8% (running year) and 5.1% for FY23.

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