Keppel Infrastructure Trust (“KIT”) recently announced their 1H2022 financial results, and it definitely raised some eyebrows seeing their distributable income decrease while distribution per unit (“DPU”) increased. There is a good reason for it, though not something everyone is comfortable with.
KIT is the largest diversified business trust listed in Singapore with approximately SGD5billion in assets under management.
The Trust was constituted on 5 January 2007 under the laws of the Republic of Singapore and registered with the Monetary Authority of Singapore (registration number 2007001).
KIT’s portfolio comprises strategic businesses and assets in the three core segments of Energy Transition, Environmental Services, and Distribution & Storage. These businesses and assets provide essential products and services across a broad range of industries; and generate regular and resilient cash flows, with potential for growth that is supported by favorable long-term market dynamics and demand. This is in line with KIT’s long-term goal of delivering sustainable and growing returns to Unitholders, through a combination of recurring distributions and capital appreciation.
Keppel Infrastructure Fund Management Pte Ltd (“KIFM”) is the Trustee-Manager of KIT. KIFM is a wholly-owned subsidiary of Keppel Capital, a premier asset manager with a diversified portfolio in real estate, infrastructure, data centres and alternative assets in key global markets.
Keppel Infrastructure Holdings Pte. Ltd., a wholly-owned subsidiary of Keppel Corporation Limited, is the Sponsor of KIT.
The breakdown of their business are as follows:
- Distribution and Network
- Energy
- Waste and Water
The Distribution and Network segment comprises of City Energy, Ixom, Philippine Coastal Storage & Pipeline Corporation and Aramco Gas Pipelines Company. This segment focus on being key producers and distributors of energy and water, such as City Energy being Singapore’s sole producer and retailer of town gas, and green energy solutions provider and Ixom being the supplier and distributor of key water treatment, industrial and specialty chemicals in Australia and New Zealand.
The Energy segment comprises of Keppel Merlimau Cogen Plant (“KMC”) which is a cycle gas turbine power plant.
The Waste and Water segment comprises of Senoko Waste-to-Energy (WTE) Plant, Keppel Seghers Tuas WTE Plant, Keppel Seghers Ulu Pandan NEWater Plant and SingSpring Desalination Plant. These assets focus on waste incineration and desalination of seawater, with major customers NEA, Singapore’s National Environment Agency and PUB, Singapore’s National Water Agency.
Key Metrics
Free Cash Flow to Equity (“FCFE”) and Payout ratio
Unlike Real Estate Investment Trusts (“REITs”), KIT is a business trust and are not imposed the same regulations as REITs.
This gives management flexibility in determining the metrics to be used. For instance, instead of using Distribution per Unit (“DPU”) as most other REITs, Free Cash Flow to Equity (“FCFE”) was used instead. There are certain considerations that need to be taken note of which will be covered in the “Key Things to Note” section later on.
Based on the announcement on 27 July 2022, it was noted that FCFE have decreased significantly by 13.0% compared to the 1H2021. This was mainly due to the the following:
- Decrease in FCFE from City Energy, noted to be due to the rising costs with the increase in oil prices
- Decrease in FCFE due to increases expenses and distribution paid to perpetual securities holders, management fees and financing costs
This metric is Unfavorable as there is deterioration in FCFE. Using the total distributions paid to unitholders of the Trust in for the first half of FY2022 of SGD95 million, the FCFE is insufficient to cover the distributions paid. This does not take into consideration the full year impact of increases in distributions moving forward into FY2022 and further increases in management fees with the changes in fee structures.
Capacity
KIT uses Capacity rate unlike REITs which uses Occupancy rates. As at 30 June 2022, KIT have met and fully utilized their capacity requirements. This is considered to be Favorable.
Gearing Ratio
Gearing ratio stands at 31.1% as at 30 June 2022 compared to 20.3% as at 31 December 2021. The increase is largely due to on 5 May 2022, KIT issued unsecured notes (the “Series 004 Notes”) with principal amount of S$250,000,000 bearing interest at a rate of 4.11% per annum under the S$2 billion Multicurrency Debt Issuance Programme. This is however still considered Favorable as it means there is sufficient headroom for KIT to pursue growth opportunities.
Interest Coverage
If using the same computation as REITs (EBIT/net interest expense), the EBIT of the trust is SGD65million while finance costs if SGD47million. This translates to interest coverage of 1.38 and thus there is insufficient interest coverage. So while they generate sufficient cash flows to pay the interest, profits are not sufficient to cover the interest expenses comfortably. This is Unfavorable in my opinion.
Debt Maturity Profile
Weighted average term to maturity of their debt stands at 3.2 years as at 30 June 2022. This is Favorable and it allows them sufficient time to refinance their debts as they fall due.
Price to Book Ratio
The Price to Book (“P/B”) ratio currently stands at 2.673 This is computed using the closing share price of SGD0.580 on 28 July 2022 and the net asset value per share of SGD0.217 as at 30 June 2022.
The P/B ratio is Unfavorable as there are other business trusts, such as Ascendas India Trust and NetLink NBN Trust, which have lower P/B ratios as at 28 July 2022.
Dividends
With the distribution announced of SGD0.00191 for the 1H2022 with payout in August 2022, KIT will be giving a dividend payout for the calendar year 2022 of SGD0.0383 per share. This translates to a healthy 6.60% dividend yield based on the current share price of $0.580 per share, and they have not missed their dividend payments since 2016.
Do note the difference in yield for 2020 was due to the their change in dividend payout policy from quarterly to semi-annually. There was thus no payout in September 2020.
Management have increased their dividend paid in February 2022, the first of such a move after years of maintaining their dividend paid. Moving forward however, it remains to be seen if their FCFE is able to sustain their dividend payout, as noted above that there is a decrease in FCFE in the first half of 2022 and expected further deterioration in FY2022.
Key things to note
Growing towards asset light
KIT has a wide range of plants and operations. By no means it is an asset light Company. However from an accounting point of view, they have been paying out dividends that are higher than their earnings. This is possible because of the high depreciation, which is a non-cash adjusting expense, resulting in high EBITDA as compared to profits.
For illustration purposes, imagine a scenario where you are in the business of car rental. The useful life of cars in Singapore companies are generally 10 years. This is due to the Certificate of Entitlement (“COE”) lasts only 10 years, and the value of the car is thus depreciated over its 10 years useful life. However, over the course of the 10 years, at the end of the useful life with the expiry of the COE, you will need to pay an equivalent amount to purchase a new car with a new 10 year COE. The new purchase would not be possible if you pay out dividends based on EBITDA and have no cash savings from the dividend expense.
What management is saying is that the assets of KIT do not have a high replacement cost at the end of its useful life. and the assets will still be able to continue to operate indefinitely. Thus they do not need to save money from the depreciation expense for a potential replacement of the assets.
The result is that the net asset value of the Company will continue to decrease as they continue to pay out the dividends sustained using EBITDA. Eventually if they would like to secure new financing, their balance sheet will seem to have insufficient assets to pledge as collateral for new borrowings.
Increasing Costs
Continued supply chain disruptions and inflation are only going to add to the costs for all businesses to run. In fact the impact can already be felt in 1H2022 for KIT, with the fall in FCFE. This is exacerbated with the continued supply chain disruptions from the Russia invasion into Ukraine, we can expect to see costs increase further into FY2022.
Furthermore, KIT have revised their fee structures, which can see that this resulted in higher payments of SGD30million in 1H2022 compared to SGD20million in 1H2021. While the fee structure have changed to be in line with unit trust holder’s interests, with fall in distributable income eventually may lead to lower dividends paid out.
Conclusion
In view of the above, there are indicators that the metrics will continue to deteriorate into unfavorable territory. Despite their stable dividend yield, investors need to continue monitoring the performance of KIT.
There is also limited opportunity for the Company to experience strong capital growth as compared to other industries where new breakthroughs can send the share prices skyrocketing. Any new growth is more likely to at best lead a small appreciation in share price.
However, as KIT is a business trust, the financials and metrics are not similar to REITs and they have different performance indicators in mind. Investors will thus have to ensure that they are comfortable with how the financials operate, and I am of the view their type of assets warrant this kind of accounting treatment.
Considering it has an expensive P/B ratio, investors should consider adding on retracements. A share price of SGD0.45 would be good given this historical trends and also will be 2 times its net asset value as at 30 June 2022.
