APA Group (ASX: APA) is a top S&P/ASX 200 Index (ASX: XJO) share in my opinion.
It may not be a household name, but it is an essential business to the Australian economy. It owns 15,000 km of natural gas pipeline that connects supply sources and markets across the Australian mainland. It delivers half of the country's natural gas usage.
Pipelines may not sound like the most exciting idea but, hopefully, the attractiveness will seem clearer once I've outlined some of the key positives.
Past performance is not a reliable indicator of future performance but I think it's worthwhile pointing out that over the past six months, the APA share price has risen by around 20%. That compares to the ASX 200 which has dropped 1.3%.
Inflation protection
Most investors are keeping a close eye on inflation and interest rates.
The higher the interest rate goes, the lower (most) asset prices are meant to go, in theory. Higher inflation could hurt household budgets as they are forced to spend more money on essentials like petrol, energy, and food.
But, APA could be protected from what's going on, thanks to how it generates its revenue, profit, and cash flow.
APA says it's positively leveraged to rising inflation with the large majority of its revenue indexed to inflation.
Contracts within Australia that contain inflation-linked escalations typically apply a formula based on either quarterly, bi-annual, or annual Australian CPI inflation. The Wallumbilla Gladstone Pipeline contract escalates annually, based on November US inflation. For the 2022 calendar year, the increase due to US inflation will be 7.5%.
In terms of APA's drawn debt, it's fully hedged with an average maturity of seven years. In other words, it won't feel the impact of higher interest rates as a cost for a while.
The ASX 200 share also boasts that it has a high earnings before interest, tax, depreciation and amortisation (EBITDA) margin. In the FY22 half-year result, the underlying EBITDA margin was around 77%.
Green energy
APA is actively participating in hydrogen feasibility projects as the commercialisation of hydrogen evolves.
For example, it's partnering to assess green hydrogen opportunities through the Central Queensland Hydrogen Consortium with the development of a hydrogen hub in the region for domestic supply and export to Japan's industrial market.
The ASX 200 share is also involved in other hydrogen efforts.
The Parmelia Gas Pipeline hydrogen project is the proposed 100% hydrogen conversion of a section of existing pipeline in Western Australia. Phase two is underway, with lab testing of the pipeline materials in gaseous hydrogen conditions.
The Victorian Transmission System is a proposal to develop Australia's first blueprint for state-wide hydrogen blending. It is believed that up to 20% of the gas being transmitted in pipelines could be hydrogen when blended with natural gas.
APA is also looking to invest in electricity transmission and renewable energy generation.
Core business growth
Management believes that natural gas still has an important role to play for decades, particularly when it comes to "affordable security of supply".
APA continues to invest in new pipelines for customers.
For example, it's investing around $460 million to build a 580km pipeline to connect the Perth Basin to the Goldfields region. This will provide an alternative source of secure energy and double the capacity, according to APA. This also creates a platform for additional growth as more resource customers seek new energy solutions to replace traditional ones.
Growth of the ASX 200 share's cash flow enables a growing distribution. It targets a payout ratio of between 60% to 70% of free cash flow.
It grew the FY22 distribution by 3.9% to 53 cents per security. That translates into a distribution yield of 4.4% at the current APA share price.
