These 4 Measures Indicate That Keppel Infrastructure Trust (SGX:A7RU) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Keppel Infrastructure Trust (SGX:A7RU) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Keppel Infrastructure Trust

How Much Debt Does Keppel Infrastructure Trust Carry?

The image below, which you can click on for greater detail, shows that Keppel Infrastructure Trust had debt of S$2.43b at the end of June 2020, a reduction from S$2.58b over a year. However, because it has a cash reserve of S$473.1m, its net debt is less, at about S$1.96b.

A Look At Keppel Infrastructure Trust's Liabilities

The latest balance sheet data shows that Keppel Infrastructure Trust had liabilities of S$1.03b due within a year, and liabilities of S$2.32b falling due after that. Offsetting this, it had S$473.1m in cash and S$318.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by S$2.56b.

This deficit is considerable relative to its market capitalization of S$2.79b, so it does suggest shareholders should keep an eye on Keppel Infrastructure Trust's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe 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.

Keppel Infrastructure Trust shareholders face the double whammy of a high net debt to EBITDA ratio (5.2), and fairly weak interest coverage, since EBIT is just 1.7 times the interest expense. The debt burden here is substantial. Looking on the bright side, Keppel Infrastructure Trust boosted its EBIT by a silky 34% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. When analysing debt levels, the balance sheet is the obvious place to start. 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, a company can only pay off debt with cold hard cash, not accounting profits. 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. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Keppel Infrastructure Trust's conversion of EBIT to free cash flow was a real positive on this analysis, as was its EBIT growth rate. In contrast, our confidence was undermined by its apparent struggle to cover its interest expense with its EBIT. It's also worth noting that Keppel Infrastructure Trust is in the Integrated 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 debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Keppel Infrastructure Trust has 2 warning signs we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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