These 4 Measures Indicate That CK Infrastructure Holdings (HKG:1038) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. 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?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for CK Infrastructure Holdings

How Much Debt Does CK Infrastructure Holdings Carry?

As you can see below, CK Infrastructure Holdings had HK$47.3b of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has HK$13.5b in cash leading to net debt of about HK$33.8b.

How Strong Is CK Infrastructure Holdings' Balance Sheet?

The latest balance sheet data shows that CK Infrastructure Holdings had liabilities of HK$11.0b due within a year, and liabilities of HK$44.8b falling due after that. Offsetting this, it had HK$13.5b in cash and HK$1.52b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$40.9b.

While this might seem like a lot, it is not so bad since CK Infrastructure Holdings has a huge market capitalization of HK$116.4b, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Strangely CK Infrastructure Holdings has a sky high EBITDA ratio of 8.7, implying high debt, but a strong interest coverage of 12.0. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Unfortunately, CK Infrastructure Holdings's EBIT flopped 16% over the last four quarters. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. When analysing debt levels, the balance sheet is the obvious place to start. 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, CK Infrastructure Holdings recorded free cash flow worth 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Both CK Infrastructure Holdings's net debt to EBITDA and its EBIT growth rate were discouraging. But on the brighter side of life, its interest cover leaves us feeling more frolicsome. We should also note that Electric Utilities industry companies like CK Infrastructure Holdings commonly do use debt without problems. We think that CK Infrastructure Holdings's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with CK Infrastructure Holdings , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. 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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