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APA - APA Group

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Value Collector said:
...

Yes, but you haven't shown that APA can't fund itself, your main concern seems to be that you think their dividends should be less, and they should be retaining cash to fund growth rather than borrowing
Click to expand...

Thought I have.

Guestimate for FY 2016:

$435M EBITDA from new WGP piplines
$553M EBITDA from old assets with 5% organic growth from those expansions (APA gave estimates of 3 to 7%)

Total EBITDA = $988M

Takes away following:
- $500M Interests
- $423M Dividends (this would be higher by 5% given APA's tendency to increase it and its HY divi up by around that too)
- $70M Stay in Biz capex
- $210M committed growth capex (this assumes it would cancel non-committed amount, else increased this to $300 or $400M)

It does not have much of a current asset to speak of. Its cash at bank of $412M would have seen some $210M being used to pay the final dividend in September last year.

From memory its receivables couldn't pay its payables... But let say it has enough to fund the committed growth capex.

So we have cash income of $988M, minus $923M (interests n divi), minus $70M to send some people out to kick some tyres and paint some rust... That alone put it under water by $5M.

It might be OK this year since the Aussie dollar is lower and it pegs its WGP to US etc. May be OK by paying final dividend in Sept...

BUt thing is, if we assume and bring these obligations back to its financial year, APA could barely pay its minimum obligations.

--

But that's not all.

You have to repay both interests and principle. With $8.6B owing over 8.8 years, that's some $977M repayment on average per year.


If it cut dividends, its operation still leave a $550M hole in debt repayment. If it cut or cancel its growth capex with the cancelled dividends, even S&P will start to wake up and re-rate this sucker.

Being under mean APA will need to borrow or raise or sell assets. Since it cannot pay its obligations from its own operations but requiring additional funding... well the only difference between APA and a jewellery ponzi is APA's pipelines can fetch a fairly good price if it's sold.

But as I've said, and I agree with you, that if APA could managed to, as it has managed to, keep on borrowing and raising capital... then it'll be fine for another few years.

Its assets is currently 70% financed by debt. I'm pretty sure not a lot of people would want to lend to it at normal rates.

---

Will try to detail comparison between APA and BNSF later in the week... but BNSF is a far more superior business with generally less debt ratio but slightly higher margins and returns.

If we then see that a railway business require more capex, more complicated operations and management than a few pipelines secured under ground - it just show how bad APA is. And the CEO got a 25% pay rise last year.
 


I think you are missing some key points here.

but firstly, let's break it down a bit (let me know which point you start to disagree)

If Apa owned all the same assets it did now, but it didn't have any debt, didn't pay a dividend, and didn't have any growth/expansion plans, would you say they couldn't fund them selves? Probably not, because they do own great assets and they would be generating lots of cash, which they could just keep at the bank piling up.

So then if instead of allowing that cash to just keep piling up earning 2% interest and losing value to inflation, would you be against them using those funds to purchase or build more assets earning a regulated 8% -12% return, that is also inflation hedged? Probably not, because you would see that owning more assets is better than piling up cash, so the growth investments are a good thing.

Now that we have realised we can invest in these assets earning 8% - 12% inflation hedged, and we realise that we can bring in bond holders happy to earn 5.6%, should we replace some of our equity interest in the projects with the bond holders, pay them the 5.6% they want and keep the remainder of the 8% - 12% their funds are earning? I think that would be smart.

Then, now that we own a big portfolio funded buy both our equity and bond holders, would it be bad to start paying ourselves a dividend, I mean we could not pay a dividend and save the cash to clear the bond holders, but we realise having bond holders if beneficial to us, we could save the cash and just use it to fund all future expansion projects with cash, but again we realise having bond holders is beneficial so we may as well fund a chunk of the future projects with bonds, and pay out any unneeded cash out as a distribution, and just keep rolling over debt and funding new assets 70/30 bonds to equity.

If you are with me this far, I think your only problem with them is the level of bond holders to equity holders eg 70% - 30%, now this isn't really a problem as it would be for other companies, because their assets produce extremely reliable earnings and the regulators take prevailing interest rates into consideration when deciding prices.

Or purchase you want them to only use debt on a temporary basis, and focus on clearing debt before dividends are paid, I see the bonds and bank bills as a permanent feature rather than short tem thing, I am fine with the rolling the bonds and paying out excess cash as dividends, if in the future the cash markets tighten, well I would be fine with them reducing of cutting dividends to clear debt, and then when cash market free up, they can bring in more bonds and distribute excess cash to bring it back up to 70/30 ratio
 

If all the premise assumed there are true, then APA is a great business. But they're not true.

First, if we assume there are no debt and there is no need to pay dividends, or taxes [who pays tax nowadays ] then APA's return is $988M.

Its assets of some $15B are all equity so its return is then 988/1500 = 6.59% return on asset/capital/equity

So that's the return APA's owner is getting.

But equity has a cost. We can now argue that the cost is 2% if that 15B is left at the bank.. but no it won't be. We could lend it to another APA, say, and get at least 5.6% - risk free [?]

But for all the trouble, and risks, APA shareholders takes on, it returns 6.59%, or 1% higher than just lending it.

either way, APA's return is not 12% or anything near that. Fact is its latest purchase returns 7.7% before depreciation maintenance costs and taxes.

-----

But say I agree that 6.6% is a good, stable, risk free return and in this environment we're happy to have it.

Then we convince others to lend us some so we can leverage up and get even better return for ourselves... Well that's what APA has done and it's in trouble if it can't get more people to convince.

Being leveraged, the $988M it now takes home (and not pay maintenance or the taxman)... some of that will now go to the lender: to a tune of some $1200M by this coming June 2016 (interests + principle; maybe p16 in 2015AR).

So already it's in a hole $210M deep.

Mgt being what they are, they want to expand and have committed another $210M with possibly up to $400M to bring the plan to completion.

$420M hole.

Then it wants to pay dividends to the tune of some $423M...

In other words, APA is in a hole and it just keep digging.

----

Maybe I miss a few crucial details that will clear it all up and we, I, will just laugh it off. But yea, so far I haven't seen it.

---------

CHARTS

Note how BNSF Net Cash Flow works as you'd expect?
That is - Net operating cash is positive and could more than pay for its Net negative Investing and Financing cash outflows [dividends, share buy backs].

Compare to APA and see also ABS where their net operating cash is tiny compare to their appetite for raising cash and "investing" for growth.

Note also the net Op. cash and vital expenses chart to the right.

See how BNSF's net operating cash is multiple times its dividend payout? 8.44 times dividends compare to APA's 1.86 times and ABS' 2.6 times (dividend paid in cash lower than actual due to DRP).










---
btw, to clarify... I don't hold or short APA. Have no financial interests whatsoever. Just doing a public service
 

Correction for above:

$988M estimate was after interests while the $1200M includes interests. Interest was estimated by APA to be $500 to $510M... so principle would be $700M. Deduct this from the EBITDA leaves $288M above water.

The hole then starts when we take away $70M in biz capex, further $210 to $400M growth capex.

Note the EBITDA of $988M assumes 5% gain on pre-WGP assets from the growth capex planned into it. So we can't take away the growth capex amount.

Hence, $288 - 70 - 400 = -$182M

the $412M cash at bank will be some $200M after it pays off last year's final dividend last sept2015. So maybe that would cover it.

But will mean no 38cents, or $423M, dividends... and APA will run out of cash to do much of anything.

With no dividends and little cash entering Fy2017, it won't last into 2018.

Hence it needs to borrow and roll over the debt. Keep up the dividends and "grow" its empire at other people's expense.

Not a stable business model.

Note that if we follow through with above assumptions, APA's assets will need over a year to sell/settled if cash is needed. So it won't sell much but raise or borrow.

But then again it had managed to pull it off for 15 years so maybe no one will be the wiser.
 
Great discussion guys. Having analysed capital intensive businesses a fair bit, I have to agree with Value Collector here on the debt being a permanent part of the capital structure. The key question is whether the 70% debt / assets ratio is too high - it's a tad high for my liking but APA has a track record of being able to refinance it and find debt capital that is willing to be "perpetual like" with repricing windows at each maturity date.

It was also mentioned that the return on the assets is <7%. This is correct but is not a total return and can't be compared against the return the bondholders get. The bondholders get 5.6% but that doesn't change or grow. The asset returns, in theory, should grow in line with volumes transported and / or CPI. So you are really comparing a ~9-10% IRR as the asset level return, which is actually not bad when considered against the risk profile of the underlying unlevered cash flows.

Using the logic applied by Luutzu, all the asset intensive sectors out there (REITs, toll roads, airports etc) are in the same boat and are not investible - a proposition I don't think is that correct. It is correct to be cautious though, as those business models generally don't fair well when there is a significant liquidity crunch particularly when it coincides with when their debt is due to expire.

Great discussion between the both of you, just adding my two cents.
 

BNSF is a capital intensive business and it managed to have net operating cash more than meeting both its dividends, interests and growth/maintenance capex.

It also borrow year on year. But those borrowings are not critical for it to meet its debt obligations.

APA just managed to refinance its debt down to 5.6% interests from around 7.7% average. If interest rate tick up a bit, and chances are it will from the current lows, its borrowing costs will change.

I do agree that if APA managed to keep finding new opportunities and can refinance as it has, it's a great business.

Being in the top 50 ASX helps with funding since managers tend to just buy into anything in top 100; that and it has a great story. But yea, people might one day ask why some one else is making money from a business mainly funded by them.
 
luutzu said:
Its assets of some $15B are all equity so its return is then 988/1500 = 6.59% return on asset/capital/equity

So that's the return APA's owner is getting.
Click to expand...

I think you have made a big error here.

You are using $15B total assets for the calculation of return on assets, however this figure includes nearly over $6 billion of assets which only appeared on the balance sheet 8 days before the end of the financial year.

They entered the financial year with about $8 billion and at the half year had about $9 billion but a $1billion of that was in cash waiting for the big transaction.

So the real return on assets is much higher than the 6.59% you calculated, also the cash that's been spent on the expansion projects won't be earning anything till the expansions are Completed, so the return on "operating assets" which is what really matters, is much much higher than your 6.59%.
 

Nope

The $988M EBITDA includes both old, organic growth, as well as the new contribution from WGP.

From APA's own estimate, they did this:

$544M "normalised" earning for 2015
+ their 3 to 7% on top from growth capex they said in the guidance (p.16 of 2015AR I think).

From a presentation before the latest one, they say they managed $12B's worth of assets (excludes the $5.8B WGP)... but say it's only $9B in assets.

($544 * 1.05)/9000 = 6.35%.
 

Dude, you are moving the goal posts here.

You said APA only earns around 6.59% return on assets, but this is not true.

In 2015, they had $822Million on EBITDA, and that was earned on around $8 Billion of capital under management, the return on their portfolio prior to the recent purchase is much better than the 6.59%, it's closer to 10%, and as I said some of that $8Billion has been sunk into projects that weren't completed in that year so the return on the operating assets would have been a little better.

Now the recent purchase seemed expensive, 7.7% return is less than I would have liked, but it is a very good asset, and because it is largely funded by debt at less than 6% it will generate operating cashflow, and over time the operating cashflow will increase, I also think strategically it will add value to the rest of the portfolio adding throughput on other pipes owned by apa, and help link the HUGE gas resources in the timor sea to the liquefaction plants, once the proposed NT connection is made.

------------------

However, lets forget about return on assets for a bit and focus on return on shareholders funds.

Net assets are around $2.5Billion, and they are producing around $550Million in operating cashflow, that's over a 20% return on the equity holders funds.

From a presentation before the latest one, they say they managed $12B's worth of assets (excludes the $5.8B WGP)... but say it's only $9B in assets.
Click to expand...

there are probably including the assets which they manage/operate under contract.

($544 * 1.05)/9000 = 6.35%
Click to expand...

Why are you using the $544M in this calculation, $544 is the operating cash flow, if you want to find out the return on assets on the $9Billion, you have to include the interest paid to the bond holders etc, other wise whats the point of that calculation.
 

Opps. Yea I put down $435M EBITDA for new WGP asset but EBTDA of $544M (after interests).

Let's then remove the estimated $320M to $350M estimated interests on WGP will leave EBTDA (net operating cash) of $435 - 320 = $115. Add 5% to the old $544 and we have 115 + (1.05*544) = $686M net operating cash after interests payment.

$686/15B in assets = 4.6%.

It's after interests return. Which makes sense because they have to pay interests. To add the interests back into will of course give a higher return, but then you'd need to take away the 5.6% interest to work out what the shareholders get anyway.




Yes. True.
Their operatingROE 2014 [2015 didn't include contribution from new WGP so ignore that] was 24%.
Chart to right show operating return on average capital employed 2014 was around 7 to 8%.




So leverage does make it better for APA shareholders as you said.

But compare this to BNSF.

Operating return still average higher than APA by about 10%; Net return (profit) on equity also very similar or slightly higher compare to APA (didn't enter enough back data to for APA to see avg).



Compare also the net return as well as operating return on average capital (R chart)... BNSF did slightly better with slightly less debt too.

That might be negligible, say, but if we consider it's a railway business with many moving parts while APA are practically just a series of pipes. APA isn't managed well at all.



Value Collector said:
there are probably including the assets which they manage/operate under contract.
Click to expand...

Yea I think they did.



Point was to look at return to shareholder for taking on all the risks, as well ask return on capital employed.

But let's assume any return above cost is good. Which it is.

But. It's not the return that kills you, it's your inability to pay your debt when they're due.

APA could not meet its loan repayment at all without further borrowing. I think we all agree with that right?

You are assuming it could just borrow because that's part of its business model. I would agree and if it could just keep borrowing, it will keep doing as somewhat OK like it has.

But if it could not. Then what?

Using its capital-intensive model is not an excuse either. As have shown, BNSF is highly intensive, probably more so than APA... yet BNSF managed to more than adequately cover both interests and loan repayment and dividends and capex with its operating income. APA couldn't.

If answer is it could just keep borrowing, well that's the definition of a ponzi.
 

I still don't get why you are comparing $686 to the $15B

I can't see how that figure is useful, if you want to judge how productive the assets them selves are, compare their earnings prior to the financing costs to the capital employed. eg EBITDA / $15B

If you want to judge the earnings on share holders funds, then compare the operating cash flow to the shareholders equity.

working it our your way would mean Cba only earns 1%, But really they have a return on equity of like 18%

But compare this to BNSF.
Click to expand...

BNSF is a railway company, why would I compare APA to it?

And as I said I own BNSF in the Berkshire portfolio already.


That might be negligible, say, but if we consider it's a railway business with many moving parts while APA are practically just a series of pipes.
Click to expand...

BNSF is an old railway, their original cost of construction on most of their networks would have been long since written off or lost through bankruptcies and reorganisations, So yes earnings will seem larger when you are working with a heavily depreciated asset compared to one which is relatively new.

How much would it cost to build the BNSF system today? Lots, no one would every build it, it would be to expensive probably 100Billion dollars, now what would its earnings look like if you compared it to the capital of a new build rail system with a capital cost of over $100Billion?

Now I am not saying that makes BNSF a bad investment, It actually makes it a great investment, I am just pointing out that you are comparing the return on assets of new assets to old assets that are sitting on the balance sheet, at depreciated levels that have been through multiple rail road reorganisations, bankruptcies and bond defaults over history of the line.








That's the same with a lot of companies out there, but Infrastructure companies find it a lot easy to get bonds than most companies, especially companies that have regulated income from assets that are almost recession proof. APA didn't have a problem refinancing during the GFC for example, and never cut its dividend, in fact it increased its dividend,

What you are really asking is, "What happens if the bond and debt markets shut down for years", well apart from the fact that this is not really a risk I find likely, after all lenders have to lend, and bondholders want to hold bonds, but they would just have to cut the dividend, accept what ever penalty rates etc apply to the bonds and set up a cash sweep.

as I said I really don't think 70/30 is a problem.




If answer is it could just keep borrowing, well that's the definition of a ponzi
Click to expand...

That's not what a Ponzi scheme is, a Ponzi scheme is where you use the capital from one investor to pay the phony interest to current investors, and the underlying assets aren't producing anything.

Just because a business model involves bonds as a permanent feature doesn't make it a Ponzi scheme, Bonds are a valid part of the capital structure in large companies, As I said a lot of pension funds etc want to hold bonds, and infrastructure companies are a good source of those bonds.
 


From APA's guidance:

$1,275M EBITDA
($500M) Net interests
($70M) Stay in biz capex [last year was $50M, new assets doubled total assets but assume it's new so $20M extra to watch and stuff)
($977M) average annual loan's principle repayment [get $8.6B owed, divided by avg 8.8 years)

Net Operating income = negative $272M

How will it pay for the shortfall?

Borrow more money. Or sell its long-term assets. Or raise capital.

So it is a business that cannot sustain itself from its own/normal operations.

But like we both agree, if it could keep borrowing to fund the shortfall, then sure it's a good business.
But then, if I managed to use people's money to fund my business and they will always keep lending it to me, I'd be onto a good business too.

We can't compare APA, at least to me we couldn't, compare this borrowing to the deposits or the premiums a bank and insurance company can use as floats.

Those floats have risk too... people can just not deposit or payout may be higher than the floats... But generally they're almost free for a financial business and people tend to keep it there on average.

But difference is, a bank and insurer don't go broke if the float is less or taken away - they just can't do as well and can't use free money; but they do not owe people their deposit or their premium if no deposit or premium were paid.

APA on the other hand, the principle repayment and the interests are required to be paid, and paid on time.
Since operations cannot return enough cash to pay for it, if APA could not find more lenders, it will go broke. If not, it will have to sell its long-term assets and so earn less money etc.

A bank is like, say, me going about my business as usual and if people give me more money at 2% and I lend it out at 4% and keep the difference, and the more I have it the better; if if I don't have it I could still be fine.

APA is like a guy that if people decided not to lend any more money, Tony Sopranos will pay a visit and take a few stuff and will be back again next year with higher interests and a hammer or two at the ready.
 
APA doesn't need to make principal payments on its debt each year. Bond debt is completely different to a Principal and interest loan.

You seem to be confusing actual maturity with the quoted average maturity.

The debt is structured so that the entire amount (8.6bil) is staggered across different tranches with completely different maturity dates. As it currently stands no more than 1.4bil matures in any given year. In fact some of it doesn't mature for 12+ years, and as much as nearly 20 years.

There's a lot of different advantages to doing it this way. I'll let you research them.

The biggest risk that any tranche won't be refinanced is if the unforseen earnings risk (or actual earnings deterioration) appears and bond / debt holders lose confidence.
 
In terms of its physical operations (as distinct from company finances) APA is in the "too big to fail" category most certainly.

Even if the company goes broke, the physical operations will continue no matter what. Worst case = government will step in (having no choice really given it's critical infrastructure).

It is also the case that no matter what happens to the company's finances overall, they are to a considerable extent backed by physical assets which have a very long lifespan that doesn't simply disappear overnight.

That aspect would be worth something I'd assume?
 

If we take EBITDA of $1275, then 1275/15000 = 8.5% return on capital employed.

So yes, I did say I agreed with you that being leveraged like APA has its return on equity is pretty decent. No argument there.

But it's not the return, low or high, that will send it bankrupt... it's its ability to repay its obligations.

So after interests of some $500M, APA also need to repay its principle (around $977M).

Can't do $1377 repayment from a $1275M income. So will be broke.

But it won't be because it can borrow or raise money - hence a ponzi.




Value Collector said:
BNSF is a railway company, why would I compare APA to it?

And as I said I own BNSF in the Berkshire portfolio already.
Click to expand...

Comparable because a capital intensive business like BNSF could actually pay all its obligations (interests and principles, and then some) with its operating cash.






Chart below show BNSF total COSTs of all its PPE+capital work in progress (CWIP) for 2008 at around $41B. This is the costs before D/A etc. After depreciation/amt, this PPE+CWIP is around $32B. Net op. cash was $3.977B. Ratio are:

NOPcash/PPE costs = 3.977/41B = 9.7%
NOPcash/PPE post DA = 3.977/32B = 12.4%



Compares APA total COSTs of all its PPE+capital work in progress (CWIP) 2014: ~$7B; book value after DA ~$6.16B. Its NOPcash for 2014 was $431.5M.
NOPcash/PPE costs = 0.4315/7B = 6.2%
NOPcash/PPE post DA = 0.4315/6.16B = 7%





I know it's one year so can't be taken seriously... but APA's latest EBITDA return was 7.7%? Somewhat in line with historical performance.


ABC Learning Centre increases its dividends too before it collapses. So were the returns to Maddoff's investors right? Not saying APA is exactly like that, but we can't just look at its dividends and growth story as genuine performance of its underlying business.

The market for debt/bonds can still be around, just it might not want to lend to APA... or not lent at low rates.

I agree that yes, companies should not have a lazy balance sheet... but at the same time, shuld not be dependent on borrowings to survive either.

I could be missing something because it seem the market is pretty happy with APA and lenders are happy to keep on lending.
 

Aware of term and maturity profile. Average for simplicity and as far as I'm concern, paying at maturity is just kicking the debt down the road.

But yea, like VC said too... there are lenders and APA have managed to get their debt rollover so might work out as it has.
 

True. That put it in perspective. Free gov't insurance policy. Though if it does hit the crunch, share price will at least halved before gov't decide how much to bail it out... opportunity at that time then, maybe?
 
So I think we have nailed it down to your main problem is that you don't like the amount of bonds they have, and I think this is down to the fact you have a wrong view of how companies like apa use the bond Market, and how the types of assets they own mean bonds are very suitable sources of long term capital.

I think the chances the bond market drying up for 8years for a company like apa is next to zero.

I can't remember whether it was in the intelligent investor or security analysis, but Ben graham spoke about this exact topic, and he said it made sense for utility monopolies to use bonds in exactly the way apa is using them.

But yeah if the "what if" scenario you are worried about is that a monopoly, with regulated income linked to interest rates won't be able to rollover it's bonds, I honestly don't know how you can invest in any equity, because every other company you look at will have real business risks that far out weigh apa's debt risks.

Any way, I have said my piece, I think you really should take back the "ponzu scheme" comment, because it clearly is not.
 


Nope. Bonds or any debt instruments where a company can cut and slice so the coupon and income streams and new rollover and maturity etc. mean it managed to survived.. that's way too much financial engineering.

Maybe old-fashion but I don't like business that relies on the kindness of lenders. Prefer that margin from its own operations to finance its divvy and also its financing.

APA couldn't do that. So no backsy on the ponzi.

But tell you what, I'll think about it taking it back after I see how Buffett's utility was doing before he bought it.

What's the pipeline again?
 
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