We bought APA in the Income Portfolio in May at $10.09 and have received one dividend, with the position down ~3% overall. We now question whether or not we have this position wrong in the short term and should cut the holding. As a refresher, APA is a leading energy infrastructure business, owning or operating around ~$22bn of gas, electricity, solar and wind assets in Australia. We know there is a huge energy transition underway, and we know APA will play a significant role within it, however, there are a few new variables to consider:
- The Victorian Government has put a ban on gas connections to new homes, and while this does not impact earnings in the near term, it will have an impact over time.
- Despite Australia’s large domestic gas supply, gas imports are now likely through the Port of Kembla from 2024 onwards, impacting current market dynamics, and potentially reducing the demand for APA assets.
- APA owns The Northern Goldfields Interconnect (NGI) supplying gas to mining developments in the mid-west region of WA. It is a new asset, completed in 2023, however, new information shows it is only 10% contracted for the next 3 years.
- Alinta Energy has four main assets in the Pilbara region of WA, and these are up for sale. APA is interested in these assets, as are others. If APA buy these assets., there is a high chance they will need to raise equity.
From a broader perspective, APA has high debt levels, underpinned by a regulated asset base with inflation-linked tariffs. While there are offsets to higher funding costs, there is still a headwind here, while growing regulatory risk in the market is another key risk to highlight. When considering an investment, we always look at it through the lens of risk v reward. We have identified some key risks above, but what are we getting paid to absorb these variables?
Currently, APA trades on a projected yield of 6.01% (unfranked) growing at ~4-5% pa, which is currently a 1.76% premium to risk-free government bond yields. Historically, they have traded at a ~2.8% spread to 10-year yields. As rates have risen since we purchased the stock, the spread has contracted from 2.17%, making it relatively less attractive.
- While APA is a high-quality, defensive yield investment, we are now questioning whether or not we are getting paid enough for the growing number of variables.
MM has turned neutral APA, now reassessing our holding
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