Here's Why CK Infrastructure Holdings (HKG:1038) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies CK Infrastructure Holdings Limited (HKG:1038) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for CK Infrastructure Holdings

What Is CK Infrastructure Holdings's Net Debt?

As you can see below, CK Infrastructure Holdings had HK$43.3b of debt at June 2021, down from HK$50.4b a year prior. On the flip side, it has HK$8.13b in cash leading to net debt of about HK$35.2b.

A Look At CK Infrastructure Holdings' Liabilities

According to the last reported balance sheet, CK Infrastructure Holdings had liabilities of HK$19.7b due within 12 months, and liabilities of HK$31.2b due beyond 12 months. On the other hand, it had cash of HK$8.13b and HK$1.44b worth of receivables due within a year. So it has liabilities totalling HK$41.4b more than its cash and near-term receivables, combined.

CK Infrastructure Holdings has a very large market capitalization of HK$119.9b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With a net debt to EBITDA ratio of 8.6, it's fair to say CK Infrastructure Holdings does have a significant amount of debt. However, its interest coverage of 6.4 is reasonably strong, which is a good sign. CK Infrastructure Holdings grew its EBIT by 7.0% in the last year. Whilst that hardly knocks our socks off it is a positive when it comes to debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if CK Infrastructure Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, CK Infrastructure Holdings generated free cash flow amounting to a very robust 89% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, CK Infrastructure Holdings's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But the stark truth is that we are concerned by its net debt to EBITDA. We would also note that Electric Utilities industry companies like CK Infrastructure Holdings commonly do use debt without problems. All these things considered, it appears that CK Infrastructure Holdings can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check CK Infrastructure Holdings's dividend history, without delay!

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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