Conservative Holding APA Group (ASX: APA, OTC: APAJF) is an original member of the AE Portfolio, one of the “Eight Income Wonders from Down Under” that comprised our lineup of top recommendations in our September 2011 debut issue.

APA, which owns and operates two-thirds of Australia’s onshore pipelines, utilizes its interconnected networks to transport approximately half the gas used domestically. Its assets include 14,120 kilometers of transmission pipelines as well as underground and liquefied natural gas (LNG) storage facilities.

It also owns and operates approximately a third of Australia’s gas distribution networks, with 25,000 kilometers of pipelines serving 1.2 million customers.

APA has also developed and acquired complementary energy infrastructure, including gas and wind electricity generation and gas processing and electricity transmission assets.

APA’s interconnected grid on Australia’s east coast is opening up a new range of services and providing shippers with new flexibility in how they manage their upstream and downstream portfolios.
Management continues to optimize the use of APA’s existing assets and to develop infrastructure and services in response to customer and market requirements.

APA is well positioned to benefit from rising domestic production and consumption and the export of natural gas in and from Australia.

A quintessential invest-to-grow story, APA consistent expansion of its fee-for-service asset base translates into reliable dividend growth for investors.

Cheung Kong Infrastructure Holdings Ltd (Hong Kong: 1038, OTC: CKISF, ADR: CKISY), joined up with affiliates Cheung Kong Holdings Ltd (Hong Kong: 0001, OTC: CHEUF, ADR: CHEUY) and Power Assets Holdings Ltd (Hong Kong: 0006, OTC: HGKGF, ADR: HGKGY) to beat out AE Portfolio Conservative Holding APA Group’s (ASX: APA, OTC: APAJF) AUD1.31 per share offer for fellow Conservative Holding Envestra Ltd (ASX: ENV, OTC: EVSRF).

But APA’s growth prospects remain bright, underpinned by Australia’s turn to natural gas as a feedstock for power generation, the mining industry’s increasing demand for the fuel and the build-out of capacity to export it in the form of liquefied natural gas (LNG).

Cheung Kong’s AUD1.32 bid for Envestra has been approved by Australia’s Foreign Investment Review Board. Conditions outstanding include acceptance by just 50 percent of Envestra’s shareholders. As of July 15 Cheung Kong’s stake was 18.7 percent, though the resolution of a dispute over the declaration date for Envestra’s final dividend for fiscal 2014 will likely spark the final push to 50 percent and beyond.

The two parties had agreed Envestra shareholders would receive a final dividend of up to 3.5 cents per share in the 2014 financial year on top of Cheung Kong’s offer price of AUD1.32 per share.

Envestra declared the final dividend on July 11. It’s payable to shareholders of record as of July 18, with an ex-dividend date of July 16.

Envestra’s independent directors have now advised Envestra shareholders to accept the Cheung Kong bid, which recommendation was withheld pending declaration of the final dividend.

Although the cash flow accretion full ownership of Envestra would likely create from fiscal 2015 through fiscal 2020 could justify a higher bid, APA is expected to book a profit on its 33.1 percent Envestra stake of approximately AUD790 million.

That will certainly boost APA’s capacity for a capital return to shareholders, as it’s highly unlikely the company will remain a shareholder of Envestra under Cheung Kong’s control. APA will likely continue to fulfill its operating and maintenance contract for Envestra’s distribution and transmission assets.

Selling into the offer will generate significant cash that can be used to fund growth and/or raise the dividend. A share buyback is also possible.

APA will have to look in other directions for opportunities to grow its asset base. The good news is there are plenty of infrastructure assets either available now or soon to be on the market, including core pipelines running from fields in Queensland’s Surat Basin to the port of Gladstone on the coast that serve Australian LNG projects.

Australia’s gas production, consumption and exports are all projected to grow through 2034-35, with domestic use forecast to increase by one third, or 1.3 percent per annum, underpinned by growth of gas-fired electricity generation from 26 percent to 34 percent of total electricity generation and increased consumption in the mining sector.

AE Portfolio Aggressive Holding Origin Energy Ltd (ASX: ORG, OTC: OGFGF, ADR: OGFGY) will likely sell pipelines that support its Australia Pacific LNG terminal in Queensland, one of four multibillion dollar ventures at the port of Gladstone seeking to convert coal seam gas to LNG for export.

And this week BG Group kicked off the auction for the approximately AUD2.5 billion to AUD4.5 billion of Queensland gas pipeline assets related to its Curtis Island LNG project, with indicative bids due by the end of August.

It’s likely that APA will compete against Cheung Kong Infrastructure in the competition for these assets as well.

The BG assets include a 540 kilometer pipeline to carry coal-seam gas from the Surat Basin to a processing plant on Curtis Island.

Cheung Kong Infrastructure will submit a solo bid. APA has teamed up with Japan-based Marubeni Corp (Japan: 8002, OTC: MARUF, ADR: MARUY).

Two other consortiums have formed among Australian and overseas investors to make offers. Industry Funds Management will bid jointly with Queensland Investment Corp and Canada’s Enbridge Inc (TSX: ENB, NYSE: ENB).

Hastings Funds Management Ltd has teamed up with Canada-based Borealis Infrastructure Trust and Germany’s Allianz SE (Germany: ALV, OTC: ALIZF, ADR: AZSEY).

APA also struck a new agreement with an existing customer for additional gas transportation and storage services on APA’s east coast grid.
The new agreement, which takes effect in September 2015, is for an initial term of seven years with an option for up to three additional years, making use of available pipeline capacity and without further significant capital investment by APA.

The agreement provides for flexible gas transportation services from multiple receipt and delivery points on the grid–primarily the Moomba Sydney Pipeline–as well as gas storage services. The total minimum revenue for the initial term exceeds AUD80 million.
APA management recently raised its earnings guidance for fiscal 2014 and boosted its final dividend.

Earnings before interest, taxation, depreciation and amortization (EBITDA) are expected to come in between AUD740 million and AUD750 million, up from previous guidance of AUD730 million to AUD740 million.

Australia’s biggest natural gas infrastructure company estimates it will pay a final distribution of AUD0.1875 per share for the second half of fiscal 2014.

Together with the interim distribution of AUD0.175, this will take total distributions for fiscal 2014 to AUD0.3625 per share, a 2.1 percent increase compared to fiscal 2013.

APA’s balance sheet is in relatively good shape given the high level of cash flow from long-term contracts the business generates.

Management recently completed the syndication of AUD1.25 billion of new loans with 16 banks to refinance some of its existing debt. APA agreed to three loans with foreign and domestic lenders to replace two that were to mature later in 2014 and in 2015.

The new loans include one AUD400 million tranche and two AUD425 million facilities, maturing in September 2016, 2017 and 2019, respectively. APA has no further refinancing obligations until September 2015.

We continue to be impressed by APA management’s deliberate approach to acquisition-led growth in recent years, including the successful campaign for Hastings Diversified Utilities Fund in 2012. Managing Director Mick McCormack is aggressive in identifying and engaging targets, prudent in backing away from potential deals with mixed fortunes.

APA would surely have benefited from consolidating ownership of Envestra’s 13,950 miles of regulated networks in South Australia, Victoria, Queensland and New South Wales, which serve approximately 1.2 million consumers. But the price it would have to pay–likely 15 percent to 20 percent above its current bid–would have eaten away at some of the value accretion.

It’s safe to assume that Mr. McCormack and his team will be serious players for the BG assets and for other pipelines built to serve the build-out of Australian LNG capacity.

APA Group is a buy under USD7 on the ASX using the symbol APA and on the US over-the-counter (OTC) market using the symbol APAJF.

APA’s fiscal year runs from Jul. 1 to Jun. 30. The company reports full financial and operating results twice a year; it typically posts first-half results during the third week of February, with full fiscal year numbers out in late August.

Interim dividends are usually declared in mid-December and confirmed with first-half results. Final dividends are usually declared during the third week of June, ahead of reporting of full fiscal year results.

The most recent interim dividend of AUD0.175 per share was declared Dec. 17, 2013; it was paid Mar. 12, 2014, to shareholders of record as of Dec. 31, 2013. Shares traded “ex-dividend” on this declaration as of Dec. 23, 2013.

The final dividend of AUD0.1875 in respect of fiscal 2014 second-half results was declared Jun. 19, 2014. It will be paid Sept. 10, 2014, to shareholders of record on Jun. 30, 2014. It traded “ex-dividend” as of Jun. 26, 2014.

Dividends paid by APA are “qualified” for US tax purposes. Based on the “fiscal cliff” compromise reached in Washington, DC, in January 2013 dividends will be taxed at Bush-era rates of 5 percent to 15 percent for investors’ first USD450,000 a year of income for couples and USD400,000 for single filers. Above that the maximum tax rate is 20 percent.

The Australian government withholds 5 percent to 15 percent, based on the US-Australia tax treaty on double taxation. The two countries have not taken the step of eliminating withholding from dividends paid in respect of shares held in a US IRA, as have the US and Canada.

Among the 15 analysts who cover the stock four rate it a “buy” according to Bloomberg’s standardization of brokerage house recommendation terminology, while nine rate the stock a “hold” and two say “sell.”

The “best consensus” 12-month target price among the nine analysts that provide such a number is AUD7.03, with a high of AUD7.68 and a low of AUD6.30.

Including a current annualized dividend rate of AUD0.3625 per share, the 12-month total return based on APA Group’s July 16 closing price on the ASX of AUD7.08 and analysts’ consensus price target is 4.5 percent.