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. We note that Keppel Infrastructure Trust (SGX:A7RU) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is Keppel Infrastructure Trust's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Keppel Infrastructure Trust had S$3.01b of debt in December 2023, down from S$3.15b, one year before. However, it does have S$479.2m in cash offsetting this, leading to net debt of about S$2.53b.

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$552.9m falling due within a year, and liabilities of S$3.28b due beyond that. On the other hand, it had cash of S$479.2m and S$360.4m worth of receivables due within a year. So it has liabilities totalling S$2.99b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of S$2.64b, 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. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 1.3 times and a disturbingly high net debt to EBITDA ratio of 6.0 hit our confidence in Keppel Infrastructure Trust like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. On a lighter note, we note that Keppel Infrastructure Trust grew its EBIT by 29% in the last year. If sustained, this growth should make that debt evaporate like a scarce drinking water during an unnaturally hot summer. When analysing debt levels, the balance sheet is the obvious place to start. But it is Keppel Infrastructure Trust's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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. 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 generation warms our hearts like a puppy in a bumblebee suit.

Our View

We feel some trepidation about Keppel Infrastructure Trust's difficulty interest cover, but we've got positives to focus on, too. To wit both its conversion of EBIT to free cash flow and EBIT growth rate were encouraging signs. Looking at all the angles mentioned above, it does seem to us that Keppel Infrastructure Trust is a somewhat risky investment as a result of its debt. 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. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Keppel Infrastructure Trust you should know about.

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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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com