Diamantina Deal Positive For APA And AGL

This story features AGL ENERGY LIMITED, and other companies. For more info SHARE ANALYSIS: AGL

-APA obtains growth and cash flow
-AGL closer to targeted asset sales
-Goldman upgrades APA to Buy
 

By Eva Brocklehurst

Brokers welcome the deal struck between joint venture partners in the Diamantina power station, AGL Energy ((AGL)) and APA Group ((APA)), believing it signals a positive outlook for both companies. AGL will offload its 50% stake in Diamantina, central Queensland, to APA for $151m, representing a small premium to book value.

The sale of the stake did not surprise Macquarie. In APA's hands the business will benefit from being part of a broader group and thus debt amortisation can be deferred. Now, post the sale of solar and gas assets, AGL should have around $900m in surplus capital that can be used for capital management. This is further evidence for the broker that AGL continues to implement its change in strategy, delivering flexibility so it can manage the uncertainty around electricity generation.

The transaction is also attractive for APA. Macquarie calculates the equity return is around 14% based on a conservative debt amortisation policy and zero terminal value in FY31. The broker anticipates that there will still be a need for residual back-up power, namely gas-fired generation, despite technology evolving in terms of battery/solar/wind by that date.

The returns stack up as APA is able to defer its debt amortisation schedule to the latter half of the project. From a cash flow perspective the company will enjoy $40-45m in additional flow and a constant debt for the next six years. Operating cash flow expectations have now been raised by 2.5% and 4.5% respectively for FY16 and FY17 and Macquarie notes, while dividend guidance is maintained, APA has a habit of surprising on the upside.

Morgans believes this move to mop up Diamantina, plus the bid for the 94% of Ethane Pipeline ((EPX)) it does not own, are indicative of the limited opportunities available to APA to deploy growth capital into its gas pipeline business. Falling commodity prices have reduced customer needs for additional gas haulage and storage services, which makes a continuation of the company's $300-400m per annum growth capex guidance beyond FY16 difficult to achieve.

The acquisitions will be accretive to cash flow, but this is not surprising to Morgans given they will be initially funded with low-cost bank debt. The broker expects Diamantina will add $88m per annum initially, with revenue certainty until 2030 supported by a tolling agreement with Glencore and Ergon Energy.

The 242MW Diamantina station and the nearby 60MW Leichhardt power stations were developed and built jointly by APA and AGL. APA will take on board the long-term service agreement with Siemens as well as the 17 staff currently operating the power station.

APA has no wholesale electricity price exposure, as nearby Mt Isa is not connected to the national electricity market. Gas is being supplied to the plant by AGL for the initial 10 years of operation with offtakers required to source the fuel gas thereafter.

APA obtains much needed growth and immediate cash flow accretion, while the asset is non-core to AGL and takes the company a step closer to its $1bn in targeted asset sales by 2017, Ord Minnett notes.

The broker revises long-term assumptions for APA, which moderates valuation, but retains a preference for the stock in the sector as it is likely to be the beneficiary of ongoing development in the domestic gas industry. The broker is also positive on AGL, given its exposure to increasing wholesale electricity prices.

APA has recently underperformed its defensive peers and Goldman Sachs believes this is an over-reaction to comments from the regulators regarding the east coast gas market. The broker believes the stock is a relatively low risk way to gain exposure to east coast gas system growth. Goldman, not one of the eight stockbrokers monitored daily on the FNArena database, upgrades the stock to Buy from Neutral.

Increased regulation could affect the long-term earnings impact of APA's key pipelines but the these may be long dated and muted by commercial offsets, the broker maintains. The two pipelines most at risk of regulation are the South West Queensland pipeline and the Moomba-Sydney pipeline. The QCLNG/WGP pipeline is not expected to be regulated as its function is to transport gas to the QCLNG project.

Goldman makes reductions to medium-term earnings forecasts based on a review of tariffs and capacity sales but considers this more than offset by the full consolidation of the Diamantina power station.

FNArena's database has three Buy ratings for AGL, with four Hold. The consensus target is $19.57, suggesting 6.9% upside to the last share price. Targets range from $18.66 to $20.55. For APA there are five Buy and three Hold ratings. The consensus target is $9.41, suggesting 5.8% upside to the last share price. Targets range from $8.70 to $10.65.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms