Looking For Stable Distributions? This Infrastructure Trust Might Interest You!

Defensive income stocks refer to dividend-paying companies operating in industries that are largely insulated from the business cycle, and whose profits and share prices are less correlated to the overall strength of the economy. As defensive income stocks tend to be less susceptible to market pullbacks, investors can count on them to provide stability to their investment portfolios in times of market volatility. For investors who may wish to introduce some dividend-generating resilience into their investment portfolios, Keppel Infrastructure Trust (SGX.A7RU) may be worth a closer look.

Overview: Singapore's Largest Infrastructure Business Trust

Touted as Singapore's largest infrastructure business trust, Keppel Infrastructure Trust (KepInfra) was formed through a merger with formerly-listed CitySpring Infrastructure Trust, with the enlarged trust holding total assets in excess of SGD 4.0 billion. The trust has a diversified portfolio of utilities, power and telecommunications assets that derive cash flows from operations such as gas distribution, wastewater treatment and power generation in Singapore and Australia. Its key assets include: two waste-to-energy plant concessions (the Tuas and Senoko waste-to-energy plants), two water concessions (the Ulu Panda NEWater and SingSpring desalination plants), town gas retailer City Gas, the Keppel Merlimau Cogen (KMC) power generation plant, and Basslink, which owns the submarine cable that provides power transmission services between Tasmania and Victoria (Chart 1).

Chart 1: Diversified Portfolio Of Infrastructure Assets

Steady Distributions Provide Significant Income

KepInfra operates in an industry that is largely insulated from the economic cycle due to the necessity of utility services. Consumers might tighten their purse strings when times are tough, but they are unlikely to terminate their gas and electricity supply, which are considered by most to be basic needs, altogether. As KepInfra's infrastructure portfolio consists mainly of utility assets that tend to generate stable and consistent cash flows, it has facilitated the trust's stable distributions over the quarters (Chart 2). Other than the one-off special distributions paid out during the merger with CitySpring and the lower distribution amount in 1Q 2015 (due to timing differences in new units issue and the acquisition of KMC), KepInfra's quarterly distribution of 0.93 Singapore cents have provided unitholders with a steady stream of realised income that can be reinvested to harness the power of compounding in growing their investment portfolios.

Chart 2: Regular And Stable Distributions Over The Years

KepInfra also pays out a much higher level of income relative to its other peers traded on the Singapore Exchange, a characteristic that adds further gloss to its investment appeal. At 7.09% (as of 1 August 2017), KepInfra's estimated distribution yield for 2017 compares favourably to that of Singapore-listed REITs, which are currently trading at an average distribution yield of about 6.02% (based on the FTSE ST REIT Index), as well as business trusts, which are offering investors a market capitalisation weighted average distribution yield of about 6.20%. Asian Pay Television Trust (SGX.S7OU), Accordia Golf Trust (SGX.ADQU) and Viva Industrial Business Trust (SGX.T8B) are the only business trusts that have higher distribution yields compared to KepInfra (Table 1).

Table 1: Highest Yielding Singapore-Listed Business Trusts

Resilient Cash Flows With Strong Earnings Visibility

No matter how profitable a company is, it will eventually have trouble paying out stable distributions at the end of the day if it runs into cash flow problems. For this reason, income-oriented investors should invest only in companies that can generate a sustainable stream of cash flows. In the case of KepInfra, its distributions look fairly secure at the moment, given that its distributable cash flows have mostly been able to support the pay-outs to its unitholders (Chart 3). It is also worth noting that KepInfra's cash flows are highly resilient and predictable as most of the its assets derive their revenues from availability-based payments, which KepInfra is entitled to regardless of actual demand as long as it makes available a certain level of capacity that is pre-negotiated with its off-taker. KepInfra's beta of 0.28 since its merger with CitySpring is also a reflection of its resilience.

Chart 3: KepInfra's Cash Flows Have Been Able To Support Distributions

Apart from CityGas, all of KepInfra's assets have fixed contracts in place, most of which are fairly long-term in nature, with tenures of about 15 – 25 years (Table 2), providing clear earnings visibility for the trust. Its off-takers, such as the Public Utilities Board and the National Environment Agency, are also highly creditworthy and the possibility of payment defaults are close to remote. Moreover, most of these contracts have cost pass-through mechanisms that insulates KepInfra from volatile energy expenses, which is a key component of its cost structure. While CityGas does not pass on its costs directly to its customers, town gas tariffs are regulated by the Energy Market Authority and designed to enable KepInfra to recover its fuel costs overtime.

Table 2: Long-Term Contracts Ensure Earnings Visibility

Balance Sheet Remains In Good Shape

KepInfra's gearing ratio of 39.1% (as of 30 June 2017) remains well below the maximum 45% gearing limit, giving it the flexibility to make further yield-accretive acquisitions should the opportunity arise, although it must be noted that the gearing limit does not affect KepInfra as it applies only to REITs, and is used in this case as a benchmark to gauge its financial position. With the Fed having resumed its tightening cycle, a rising interest rate environment is expected to put downward pressure on distributable income as debt servicing costs rise. However, approximately 87% of KepInfra's interest costs are fixed in nature and with just 1.5% of its outstanding debt coming due within a year, its refinancing risks are limited as well, putting it in good stead to withstand any short-tern negative impact arising from rising interest rates. KepInfra's loans have a weighted average term to expiry of 2.6 years, with 97.4% of them coming due over the next 1 – 5 years.

While KepInfra has fairly high gearing and net debt-to-equity ratios relative to its peers (Table 3), it is due in large part to Basslink, which has a highly leveraged capital structure, with a SGD 735.6 million loan to service. Excluding Basslink, KepInfra's gearing and net debt-to equity ratios come down substantially to more favourable levels, at 49.3% and 29.6% respectively. It is worth noting at this juncture, that KepInfra does not use the cash flows from Basslink for distribution purposes. Instead, any excess cash is used to pay down the amortised loan and lowering its interest costs in the long-run. Hence, an underperforming Basslink is unlikely to threaten KepInfra's future distributions.

Table 3: Debt Ratios Of Selected Business Trusts

Future Growth Prospects Abound

The management has indicated that the trust is able to borrow about SGD 500 million for acquisitions – a key stock catalyst – to supplement future growth before it hits the 45% gearing limit. The right of first refusal (ROFR) option provided by its sponsor, Keppel Infrastructure (KI), allows the trust to leverage on group synergies to obtain new assets. There are currently six assets in the sponsor pipeline, most of which are district cooling systems (DCS) developed by KI, that could potential be acquisition targets for KepInfra (Table 4). The management has also indicated its willingness to look beyond the sponsor pipeline for third-party acquisition targets with assets that generate long-term stable cash flows, in sectors such as energy, telecommunication services, water and waste management.

Table 4: Asset Pipeline From Sponsor

There is also organic growth potential in KepInfra's existing portfolio as some assets – Basslink, KMC and DataCentre One – have contract extension options in place. DataCentre One also has the potential for two additional storeys to be fitted out to increase future cash flow contributions without the need for huge capital outlay. With total piped town gas sales on the rise over the years (Chart 4), the increasing acceptance of piped gas as a fuel source bodes well for KepInfra, with CityGas' joint venture with Osaka Gas (City-OG Gas Energy Services) to market and sell natural gas to industrial customers in Singapore also representing another source of organic growth. As mentioned earlier, KepInfra does not currently use the cash flows from Basslink for distribution purposes. When it does eventually resume its cash flow contributions, however, unitholders could be looking at a potential increase in distributions.

Chart 4: Increasing Use Of Town Gas Over The Years

Attractive Return Potential!

The net asset value (NAV) is typically used to assess the intrinsic value of a company whose underlying portfolio consists mainly of hard assets, like real estate properties, that can be sold in the market. Theoretically, if the company is liquidated, investors should be able to get back assets equivalent in value to its NAV. While KepInfra's current share price of SGD 0.55 (as of 1 August 2017) appears overvalued when compared to its NAV of SGD 0.307 per unit (as of 30 June 2017), it must be noted that KepInfra's NAV is not a fair gauge of its value as there is no readily available market for its utility assets, which are carried at cost on its book.

A more suitable valuation method would be the dividend discount model as KepInfra pays a regular distribution to its unitholders. Assuming a discount rate of 6.2% (calculated using the capital asset pricing model), an adjusted beta of 0.52 and a conservative zero dividend growth scenario, the simplified model yields an estimated target price of SGD 0.60 (Chart 5), which seems to suggest that KepInfra may be undervalued at its current price, with an attractive potential upside of 9.1% – and that is excluding its estimated dividend yield of 7.09% for this year!

Chart 5: Using The Dividend Discount Model To Estimate Intrinsic Value

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.

The Research Team is part of iFAST Financial Pte Ltd.