Does Keppel Infrastructure Trust (SGX:A7RU) Have A Healthy Balance Sheet?

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. As with many other companies Keppel Infrastructure Trust (SGX:A7RU) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Keppel Infrastructure Trust

What Is Keppel Infrastructure Trust's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Keppel Infrastructure Trust had S$2.77b of debt, an increase on S$2.25b, over one year. On the flip side, it has S$332.3m in cash leading to net debt of about S$2.43b.

How Strong Is Keppel Infrastructure Trust's Balance Sheet?

We can see from the most recent balance sheet that Keppel Infrastructure Trust had liabilities of S$1.21b falling due within a year, and liabilities of S$2.31b due beyond that. On the other hand, it had cash of S$332.3m and S$394.2m worth of receivables due within a year. So its liabilities total S$2.79b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of S$2.67b, we think shareholders really should watch Keppel Infrastructure Trust's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 1.7 times and a disturbingly high net debt to EBITDA ratio of 5.6 hit our confidence in Keppel Infrastructure Trust like a one-two punch to the gut. The debt burden here is substantial. The good news is that Keppel Infrastructure Trust grew its EBIT a smooth 91% over the last twelve months. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Keppel Infrastructure Trust can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Happily for any shareholders, Keppel Infrastructure Trust actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Both Keppel Infrastructure Trust's ability to to convert EBIT to free cash flow and its EBIT growth rate gave us comfort that it can handle its debt. But truth be told its net debt to EBITDA had us nibbling our nails. It's also worth noting that Keppel Infrastructure Trust is in the Gas Utilities industry, which is often considered to be quite defensive. When we consider all the factors mentioned above, we do feel a bit cautious about Keppel Infrastructure Trust's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Keppel Infrastructure Trust (at least 1 which is significant) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.