APA Group APA ★★★★

APA Group's first-half fiscal 2025 EBITDA rose by 9% to $1.02 billion, and management reaffirmed full-year guidance, which at the midpoint implies growth of 5% on last year. The market responded positively, with the stock up 8% on the day.

Why it matters: A solid underlying result, with EBITDA growth of 4%, excluding the acquisition of Pilbara Energy Systems. We leave our forecast fiscal 2025 EBITDA of $1.99 billion unchanged, in the middle of guidance.

  • Free cash flow per security was flat at $0.43 in the half and likely to fall in the full year, mainly because of higher interest costs and equity dilution relating to the Pilbara acquisition. However, further acquisitions are unlikely, and developments should deliver better returns.
  • The focus is back on cost control after rapid growth in recent years to support expansion into new areas. Management guides to Consumer Price Index-like growth in corporate and operating costs in coming years on streamlining operations and supply chains, as well as IT system upgrades.

The bottom line: We maintain our $9.30 per security fair value estimate and consider narrow-moat APA materially undervalued. Distribution yield is high at 8%, and we expect distributions to grow at close to 2% per year for the medium term.

  • APA's security price tanked in recent years as free cash flow per security stagnated. A big part of the problem was aggressive expansion into renewable energy, including the dilutive Pilbara acquisition, and runaway costs. The outlook is now improving.
  • The key remaining earnings headwind is the rising costs of debt as interest rate hedges mature, but this should be manageable. The average cost of debt increased by 50 basis points to 5.1% in the half, and we expect it will rise over 6% in the medium term.

APA Group business strategy and outlook

APA Group is Australia's premier gas infrastructure company. Limited regulation, scale, and a superior skills base help it capitalize on gas demand growth and generate competitive advantages that warrant a narrow economic moat. However, gas market reform and potential regulation of pipelines could weaken its competitive advantages. Fair value uncertainty is medium, as secure revenue is balanced by high gearing and limited transparency over customer contracts.

Gas transmission and distribution is the core business, generating more than 80% of group EBITDA. Power generation—wind farms, solar farms and gas power stations—contribute about 11% and electricity transmission, asset management and investments contribute the balance. The investments division owns stakes in small energy infrastructure companies and the asset management division provides management, operating, and maintenance services to third parties and part-owned companies, leveraging APA’s skills base.

APA’s long-distance gas transmission pipelines and power generation assets typically operate under long-term, CPI-linked contracts with energy retailers, LNG exporters, and major industrial/mining companies. Returns are traditionally 100 to 200 basis points above regulatory returns to compensate for higher demand risk. Electricity transmission and gas distribution networks are regulated, with returns set by the Australian Energy Regulator to provide fair profits after covering reasonable costs.

APA Group's core strategy during the past decade has been to create an integrated east-coast gas transmission grid connecting multiple gas sources to multiple markets. This is now complete following numerous acquisitions and the firm is progressing a similar strategy in Western Australia, connecting to remote mine sites and towns. Expansion creates economies of scale and synergies from linking pipes together into a network with one manager. Further acquisitions of transmission pipelines are unlikely given competition concerns, but organic expansion is ongoing.

Ampol Ltd ALD ★★★★

Refined fuel retailer Ampol reported underlying 2024 EBIT down 45% to AUD 715 million and underlying net profit after tax down 74% to AUD 182 million. The result reflects a 45% decline in the Lytton refiner margin to USD 7.08 per barrel and a sharp drop in refining EBITDA to $23 million.

Why it matters: Underlying earnings before interest and taxes (“EBIT”) was in line with guidance and our expectations, but net profit after tax (“NPAT”) was well below due to higher-than-anticipated net interest expense. However, we think this is a low point for the business, and better can now be expected.

  • Soft global refining conditions affected. Fuels and infrastructure wore higher one-off costs to maintain supply after Lytton experienced a series of unplanned outages. International saw limited value-creating opportunities, given low volatility levels and a well-supplied market.
  • However, convenience retail has begun 2025 solidly, and there are early positive signs from New Zealand trading. Refining cracks have strengthened by around USD 2 per barrel through February, and Lytton is expected to benefit from improved reliability, reducing the cost of supply and freight.

The bottom line: We reduce our fair value estimate for no-moat Ampol by 7% to $32.50 after higher-than-expected group capital cost guidance of $600 million for 2025, in addition to Z Energy's 2024 operating costs proving stickier than expected.

  • Ampol shares are down a third from April 2024 highs and, at around $27, are somewhat undervalued. We think the market doesn't yet fully accept that Ampol is now likely past a low point for the cyclical part of its business, chiefly refining.
  • Our 2025 earnings per share forecast declines by 7% to $2.50 after factoring in higher interest expenses and the Z Energy cost increase. Expectations for other segments are unchanged. We reduce our 2026 dividends per share forecast in kind to $1.50. This equates to a midrange 5.5% fully franked yield at the current share price.

Ampol business strategy and outlook

Ampol owns and operates a major refined petroleum product import terminal at Kurnell in Sydney and a refinery at Lytton in Brisbane. Annual refining capacity fell by half to 6.0 billion liters, about one third of company marketed volumes, when Kurnell closed. Kurnell refinery was shut in 2014 because of operational issues and unfavorable demand for the product mix. Refineries and finished product import terminals are integrated with pipelines, distribution, and marketing. The national service station network exceeds 2,000, including 350 jointly branded Ampol/Woolworths (ASX:WOW) sites.

Strong growth in transport fuels reflects favorable market attributes. Australia's relatively sparse rail network and low population density favor trucks for distribution of goods. Pandemics notwithstanding, volumes in the Australian liquid fuels market grow at close to growth rates in gross domestic product, with solid increases in diesel and jet fuel consumption offsetting a slow decline in petrol.

Ampol's extensive network and comprehensive product offerings provide some competitive advantage. A very efficient supply chain makes Ampol an effective competitor. Still we don't see this as sufficient to justify a moat rating other than none. The closure of refining sees Ampol's business rest largely on fuel distribution. In this space, it wrestles with expert competition in BP, Shell, and ExxonMobil. Potential long-term threats include substitution of diesel for alternative fuels such as liquid natural gas, or LNG, and electricity. In the case of LNG in particular, Ampol is likely to participate in any shift via its logistics network and filling stations.

Ampol maintains a market-leading 35% share of all transport fuels sold. Ampol substantially rests on its competitive supply chain now that Kurnell has been converted into an import terminal. Competitive pressures in the refining segment meant Ampol could not earn its cost of capital on Kurnell. The highly profitable and fast-growing marketing segment can enjoy increased investment that was previously wasted in laggard refining.

Ampol successfully completed a NZD 2.0 billion bid for New Zealand peer Z Energy in first-half 2022.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn more about how to identify companies with an economic moat, read this article by Mark LaMonica.