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

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, CK Infrastructure Holdings Limited (HKG:1038) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for CK Infrastructure Holdings

What Is CK Infrastructure Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that CK Infrastructure Holdings had HK$43.7b of debt in June 2021, down from HK$50.4b, one year before. However, it also had HK$8.13b in cash, and so its net debt is HK$35.6b.

A Look At CK Infrastructure Holdings' Liabilities

The latest balance sheet data shows that CK Infrastructure Holdings had liabilities of HK$19.7b due within a year, and liabilities of HK$31.2b falling due after that. Offsetting these obligations, it had cash of HK$8.13b as well as receivables valued at HK$1.44b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$41.4b.

This deficit isn't so bad because CK Infrastructure Holdings is worth a massive HK$115.8b, and thus could probably raise enough capital to shore up 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 measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

CK Infrastructure Holdings has a rather high debt to EBITDA ratio of 8.7 which suggests a meaningful debt load. However, its interest coverage of 6.4 is reasonably strong, which is a good sign. We saw CK Infrastructure Holdings grow its EBIT by 7.0% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine CK Infrastructure Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, CK Infrastructure Holdings generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Based on what we've seen CK Infrastructure Holdings is not finding it easy, given its net debt to EBITDA, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its conversion of EBIT to free cash flow. It's also worth noting that CK Infrastructure Holdings is in the Electric Utilities industry, which is often considered to be quite defensive. Considering this range of data points, we think CK Infrastructure Holdings is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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!

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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