APA Group: Expensive Debt and Equity Should Force the Company to Recalibrate Strategy

APA Group’s APA renewable transition strategy is too aggressive. The cost of debt and equity has increased with higher interest rates and the firm’s lower share price. However, management continues to pursue low-quality and low-returning renewable energy acquisitions and developments. Relatedly, APA Group suffered the first strike against its remuneration report at its recent annual general meeting, which we think was because bonus targets for management are overly focused on driving the renewable transition instead of improving returns for shareholders. We downgrade APA Group’s Capital Allocation Rating to Poor. We’d likely return the rating to Standard if management becomes more disciplined with investment decisions or if it can sufficiently improve returns from new investments. Alternatively, bond yields could fall and negate the pressure on equity returns.

We downgrade our fair value estimate by 2% to AUD 9.30 per share to reflect the recent expensive debt issuance. Nonetheless, APA Group remains undervalued. More than 80% of the company’s EBITDA comes from its high-quality gas transmission pipeline networks, which should be able to increase tariffs to reflect higher funding costs—as reflected in APA Group’s narrow economic moat. The large network also provides value-accretive expansion projects such as increasing throughput to transmit more gas from Queensland to southern states and expanding the Western Australian network to allow more remote mines and towns to ditch costly and polluting diesel generation. The appeal of these projects is that APA Group’s solutions are cheaper than competing options, and thus can generate strong returns.

While we think APA Group must invest in the renewable transition to maintain support from the government and banks, it needs to recalibrate return expectations upward because of higher costs of funding. If this means losing out on acquisitions, so be it.