Keppel Infrastructure Trust: Resetting expectations
- Downgrade to HOLD with revised TP of SGD0.45 1Q25 core distributable income lower y/y, driven by weaker contributions from EMK, wind farms, Senoko WTE
- Completed sale of Philippine Coastal asset in 1Q25, lowering gearing to below 40%
- Distributions unlikely to be hit by tariff wars, but rising capex and other factors may limit DI visibility in FY25 and beyond
- Downgrade to HOLD with revised TP of SGD0.45
KIT has underperformed SREIT Index. KIT distributions have been more stable than SREITs in general over the last few years, yet share price has underperformed by almost 10ppts since 2023, as can be seen in the chart below. The weak share price performance of yield plays like KIT and SREITs is a function of prevailing high interest rates in recent years given the Fed interest rate cycle, but this does not fully explain the gap. Thus, it could be possible that investors have turned more cautious on the name due to weaker cash flow visibility or the possibility of further equity fund raising and dilution.
M&A impetus has not resulted in significant DPU accretion over time. While the Trust’s management has been busy executing accretive M&A deals over time, expanding more into evergreen businesses as opposed to fixed life concession assets, DPUs have remained stable or only increased a notch in recent years – barring the special dividends in FY23 that were driven by capital optimisation proceeds rather than operating profits. While it is true that contributions from new assets have helped to partially tide over loss of income from expiring assets like Senoko WTE and higher amortisation payments at KMC, some of the assets have not performed to their potential (EMK, European wind) and high management fees and fund raising expenses have also eaten into distribution income.
There may be concerns over stability of distribution income. For a Business Trust like KIT, cash flows are expected to be predictable and for a long time, they were – even during the COVID crisis. Since 2023, cashflow has been harder to predict and cashflow timing has been less consistent with one offs and adjustments etc which do not make for great reading. DI in both 2023 and 2024 came in lower than 2022 levels, and distributions in 2023 were shored up by proceeds from “capital optimisation” (debt refinancing). This is a trend that is concerning. Going forward, higher than expected capex – both maintenance capex and growth capex – could again lead to volatility in DI.
Change in key metric from DI to FFO presents some concerns. Funds from Operations (FFO) is a metric that is calculated before mandatory debt repayment and discretionary growth capex and hence, comparing FFOs over time ignores the impact of timing of such cash flows. The Trust may need to incur growth capex that is more long term in nature and returns may not be imminent, especially for non-regulated assets like Ixom. Under these circumstances, DI may be falling even though FFO is increasing, and hence investors may not get the complete picture by focusing on FFO in our opinion.
Trust’s balance sheet presents no immediate concerns but is more stretched than before. The Trust’s gearing metrics stand above 40% (before Philippine Coastal disposal) and are above MAS guidelines for SREITs (which is also an internal benchmark for KIT), though Business Trusts have no restrictions as such. Including perps as debt for stricter analysis, credit metrics look stretched in our opinion. We see limited further debt headroom for growth, and KIT may need to tap on equity market for any future transactions. The question is – at current yields of c.10%, can public equity markets be the reliable funding source the Trust is looking for? And how will that affect the Trust’s ability to grow?
Overall, we have a more cautious stance on KIT and lower our recommendation to HOLD with a revised TP of SGD0.45. After factoring in higher Trust expenses and higher cost of capital amid uncertain macro environment, our DDM-based valuation is revised down to SGD0.45 per share. While the Trust is currently trading at a healthy yield of around 10%, the weak share price performance YTD highlights that KIT needs to inspire more confidence in its ability to generate stable cash flows. Clearer visibility on distribution sustainability is needed before a re-rating can be expected.
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