​Floated in 2010, Aurizon has certainly seen ups and downs over the past decade. Before we get to the details, a brief overview of the company. Originally known as QR National, the company was established in 2004 bringing together Queensland Rail’s coal, bulk and containerised businesses. It grew by acquisitions over the following decade, expanding nationally and taking over Australian Rail Group and CRT, giving it a footprint across NSW, Victoria and WA. To put it simply, the company provides design, construction, overhaul, maintenance and management services to the mining industry with the bread butter remaining the Central Queensland Coal Network (CQCN). Given the loss of appetite with regards to coal and fossil fuels, the business has seen significant headwinds since IPO. With the likely long-term decline in its traditional business, it may seem surprising to many that we would even consider it. However, it must be viewed as a business in transition.

While we see significant declines in the market for thermal coal, we also see continued demand for metallurgical and coking coal, a key ingredient in the manufacture of steel. This is one segment that is likely to continue to see tailwinds given the impetus for spending on infrastructure globally. If spot prices are anything to go by, close to doubling in the past year, we are seeing significant pockets of value in the space. In fact, the company expects haulage volumes for 2021 to increase by 5%. Drilling down further, while we have seen flatlining or declines in crude steel production in China we are likely to see this cushioned by increases in India and across Asia (including Japan) as nations embark upon upgrading their own infrastructure. In our view, it is rather telling that the business extended its contracts with its biggest customers, including Glencore (GLEN.LON), Anglo American (AAL.LON) and New Hope (NHC.ASX).

​​For those still not convinced, there is a clear strategy from management that takes into account the long-term structural headwinds facing the industry. This includes declines in the demand for thermal coal with a target to reduce exposure to thermal coal to less than 20% of Above Rail revenues by 2030. This is a more than rational business decision given that the world will still require Thermal during the ongoing transition period. Look to the recent example of China, a situation which has resulted in spot prices sky-rocketing to $170 USD/Tonne (doubled on a 12-month basis). Despite the government’s adamant assertion of zero-emission targets, a heat wave in Zhejiang, Jiangsu and Guangdong (her biggest industrial provinces) saw output pushed higher and bottlenecks during peak demand. It is also quite telling that policy makers have restarted production in the Shanxi and Xinjiang provinces (a region prone to flooding, by the way). Suffice it to say, these bottlenecks mean that the AZJ’s 20% target may not be as much of a liability as we still see the economics making sense over the medium-term.

Moving away from coal, Aurizon continues to focus on its bulk business which has seen significantly higher volumes. Customers here include the likes of South32 (S32.ASX), CBH Resources and mineral resources with exposures split nicely across iron ore, base metals and agriculture (i.e. grain). All exposures that we continue to see demand for within the Green Economy.

So, why does it make sense? 

We feel that it currently trades at the valuation of a pure fossil fuels play with little thought given to the active transition occurring. Management has a clear strategy for diversifying the business substantially through value add, as is indicated by the purchase of Newcastle and Townsville shipping facilities, which adds storage and ship loading capabilities along with potential for near-term organic growth prospects in the lithium and mineral sands space. Moreover the nature of the businesses, including long-contracted revenues (insulates the investor from fluctuations within the day-to-day gyrations of the spot market) and capital intensity (creates high barriers to entry) make it a reasonable risk-reward proposition.

With that, let’s quickly get to the numbers. EBITDA at $1.482bn AUD, statutory NPAT at $607m AUD, and FCF (Free Cash Flow) of $734m AUD. Interestingly, management’s guidance (and our expectations) are that we are likely to see $ 1.5bn for EBITDA. Granted, this is on the upper end of the guidance but we see no reason for this not to be the case.

Red Flags & Risks: This remains an annuity-like return stream for the discerning investor but the risk for capex blowouts remains the same as well as shorter term volatility within the coal and minerals market. Non-growth capex guidance for FY22 came in at $475-525m, however the question mark remains around the capex required for growth in the bulk side of the business.

In addition, China’s confrontational approach to Australian coal exports continue to be a headwind for the markets though this has been priced in and the company has made some headway in outlining a clear strategy for alternative markets (i.e. India and South East Asia).

Dividend Yield: A stellar 7.2% and we see this continuing to be the case over the long-term on the balance of probabilities.

​Despite this series mostly focusing on unloved businesses, APA came across our radar when they outlined their strategy for the next generation of growth in renewables and expansion into the lucrative US market.

First, a brief history and overview.

Listed in 2000, the Australian Pipeline Trust is an offshoot of AGL (AGL.ASX) starting with an interest in 7,000km of transmission pipelines. APA today owns and operates over 15,000km of pipelines along with 27,000km in Gas Distribution Mains as well as storage facilities, power stations, wind and solar farms. It accounts for the transportation of a quarter of gas used in Australia. Investors in the parent must be thinking of the irony. APA with a market capitalisation of $11.5bn AUD and AGL with its market capitalisation of $4.5bn AUD, a clear showcase of value creation vs. destruction by management teams. Nevertheless, we shall stop there given that we’ve previously posited that AGL looks relatively cheap.

We see significant tailwinds for the company going forward as the domestic market transitions toward renewables and energy security. Natural gas, in our view, will continue to be a key component of the energy mix going forward. Also telling is the continued expansion domestically of the East Coast gas grid in the Southern states, despite increased regulatory scrutiny on the domestic gas market. The transport agreement with Origin (ORG.ASX) has substantially de-risked this but the very manner in which management has gone about building the business and opportunity set is a great start. So, what does this entail? Firstly, it upgrades both the South West QLD pipeline and Moomba Sydney Pipeline and enables an 25% capacity increase via compression (as opposed to building new pipelines) with Origin coming in to take some of the increased capacity and locking in incremental revenue of $190m AUD over a 3-year period for the privilege of doing so.

We see similar capacity improvements across APA’s footprint along with continued optimisation of existing infrastructure. While many in the industry have faced significant headwinds due to regulatory intervention, APA’s astute management has found themselves continuing to operate in the overlooked niches (i.e. less regulated) where they can take advantage of asymmetric information in negotiation. On the flip-side, while it is likely that there will be additional construction of new import terminals by retailers, a policy likely to be encouraged by governments seeking to increase competition in the domestic market APA’s pipeline footprint makes it an attractive and cheaper alternative at least in the short-run.

Looking to the future, management’s vision is what we find to be the most attractive proposition. First, the potential expansion of the domestic footprint looking to capitalise on the close to $68bn AUD opportunity set that is Australia’s transition to renewables by 2040. Management estimates that pipelines and associated infrastructure is worth about $8bn, $40bn AUD in generation and storage and $20bn AUD in transmission. We see APA as a leading contender for the lion’s share of the pipelines and associated infrastructure with management potentially developing additional capabilities in storage and transmission. That being said, they may not be able to ascertain outsized returns outside the core capabilities during the initial stages. We also see the business as more likely to focus on wind generation as opposed to solar in order to prevent downward pressure on prices during the day.

Looking beyond Australia, management has indicated a desire to enter the US market where a significantly larger $2.5tn USD opportunity is up for grabs to 2040. This includes the potential for buying out existing pipelines or a utility company during the initial stages. With the enormity of the transition taking place, they may be able to buy out a non-core asset from an energy company before expanding further. While there is obviously risk there, we feel the APA has the track-record and the expertise to move into the space. In addition to looking at diversifying the pipeline usage, one interesting idea floated was the potential to use the existing pipeline infrastructure, initially the Parmelia Gas Pipeline, for the transportation of hydrogen with the potential to export at a later date.

With that, let’s get to the numbers. First half EBITDA came in at $823m AUD, down slightly (-2%) but expected due to Covid, and, concerning energy consumption for the full year, our view is that the figures will come in at a slight decline of -1.2% for the full year ($1.6bn AUD). NPAT at $290m AUD, an estimate and based on management guidance.

A fairly valued stock but still a reasonable buy, a strong well run defensive investment with growth attributes. ​

Red Flags & Risks: The biggest risk remains the aggressive expansion strategy that management is likely to implement (also happens to be the most attractive attribute). Debt is likely to be on the upper end of the metric allowances for a BBB/Baa2 credit rating should they proceed with an acquisition and, while the regulated return on equity allowances in the US should they proceed remains an attractive 10%, the risk of overpaying especially given the environment remains.

Over the long-run, an increasingly confrontational regulatory environment in the Australian market remains a threat along with increased competition.

Dividend Yield: An attractive 5.1%.