DBS: Keppel Infrastructure Trust – Buy Target Price $0.60

DPU up slightly in 1H22, renewables story added in M&A mix

KIT declared higher DPU of 1.91Scts in 1H22, up 2.7% y-o-y, though distributable income lower than expected, on the back of cash flow timing differences and one-offs
M&A ambitions continue unabated, impressive line up of completed and proposed deals this year
First foray into renewable energy space with onshore wind portfolio investment in Europe, cementing sustainability story
With yield of 6.7% at current prices, and exciting inorganic growth play, we maintain BUY

Distributable income lower than expected in 1H22, but DPU continues to inch up

KIT recorded distributable income of S$87.6m in 1H22, down 13% y-o-y and 4% q-o-q, even as core EBITDA (excluding one-offs) grew 10% to S$172.6m.
The lower 1H22 distributable income was largely due to City Energy (previously City Gas) numbers being impacted as a result of the timing differences in the fuel price pass through gas tariff mechanism. This will be recovered through higher gas tariffs in future.
KIT also recorded one-off acquisition related costs amounting to SS$31.8m in 1H22, including S$22m acquisition fees (part of management fees) related to the acquisition of minority stake in Aramco Gas Pipelines, which is higher than expected.
Finance costs were also higher owing to the issue of S$250m MTNs to finance the acquisition of the Aramco Gas Pipelines stake, which will only start contributing to cash flows from 3Q22.
Despite the lower distributable income, management decided to retain the DPU growth story started in 2H21, as underlying businesses are performing well – led by Ixom – and income should recover in 2H22 as City Energy contributions smoothen out, new assets start contributing and one-off costs are reduced.
Management expects to grow DPU by at least 1.5-2% every year, beating long term inflation trends in Singapore.

Renewable investments gather steam

KIT has recently proposed its maiden investment in the renewable energy space, in tier 1 markets in Europe, committing up to EUR160m (S$233.6m) investments through a 82:18 JV with Keppel Renewable Investments, a wholly-owned subsidiary of Keppel Corp.
KIT will be investing into a platform sponsored by Fred Olsen Renewables with an initial portfolio of three operating onshore wind farms in Sweden and Norway with a combined generation capacity of 258MW, and remaining asset life of around 21 years on average.
We estimate KIT will need to invest around S$70m for an effective minority stake of 13.4% in this first tranche of assets, which is expected to be completed by 3Q22, and contribute around S$5+m in distributable income per annum.
Apart from these operating projects, there is another 1.3GW of pipeline potential – 5 projects (305MW) that will reach FID within next 3 years and another 10 eligible projects (955MW).
Assuming full utilisation of KIT’s commitment amount over a period of time, this will take the Trust’s renewables exposure to approximately 4% of assets under management.
In addition, KIT had earlier signed an MOU with Jinko Power of China to jointly explore solar farm and energy storage projects.
Jinko Power will over time identify up to 1,000MW of developmental and operational assets in key developed markets of APAC, Europe and the Middle East for KIT’s consideration.
KIT has a target to increase exposure to renewable energy by up to 25% of KIT’s equity-adjusted AUM by 2030.

M&A story impressive elsewhere as well

Apart from the push in the renewables space, KIT has completed the acquisition of minority stake in Aramco Gas Pipelines Company, which holds a 20-year lease-and-lease-back agreement over the usage rights of Aramco’s gas pipelines network, and will start contributing to distributable income from 3Q22 onwards, as highlighted earlier. KIT’s equity investment is worth US$250m (S$347m).
In addition, KIT is leveraging on sponsor pipeline by signing a term sheet to acquire 50% stake in the Keppel Marina East Desalination Plant, which is structured so as to give KIT 100% economic interest in the asset. Enterprise value of the deal is around S$355m, but equity investment will be lower owing to significant debt in capital structure at asset level. The plant is of similar size to SingSpring and should contribute upwards of S$10m in distributable income per annum, according to our estimates.
KIT has also completed the acquisition of the remaining 30% in SingSpring desalination plant in June 2022 and now owns 100% instead of 70% earlier, hence will be benefiting from enhanced contributions from this asset, going forward.
KIT’s wholly owned asset Ixom has also completed the S$72m acquisition of Bituminous Products, one of Australia’s leading manufacturers and suppliers of bitumen-based and associated products for road surfacing and general industrial use, which will boost Ixom’s growth prospects further.
On to Korea now? KIT – as part of other Keppel vehicles in a consortium – has been selected as preferred bidder to buy Eco Management Korea Holdings, a major integrated waste management player in South Korea, according to press reports, and management has confirmed this development but negotiations are still ongoing and not finalised. The deal value may be close to ~US$500m (~S$700m) overall.

Balance sheet in shape, rising interest rates not a big concern

Borrowings have increased in 1H22 to fund acquisitions, and net gearing (debt/ asset) is up to 31.2% at end-1H22 from 22% at end-FY21. This is still very reasonable level and implies S$700m headroom before gearing hits 45% level, which is the SREIT benchmark. Of course, business trusts like KIT have no regulatory limit and can lever up more, if required. Net debt/ EBITDA of 4.2x is also no cause for concern.
KIT is currently undertaking a strategic review of its 100% stake in Ixom, with a view to potentially unlocking value from the business through divestment at attractive valuations. Target completion is by 1H 2023, and capital will be redeployed for growth. This should enable the Trust to boost distributable income over the next few years and more than offset cash flow loss from expiring assets like Senoko WTE plant (2024) and SingSpring (2027).
Weighted average interest rate right now is around 2.5% and weighted average term to maturity of loans is 3.2 years. KIT has hedged ~90% of its loans. With 90% hedge in place, a 100 bps change in interest rate would have around 1% impact to distributable income, according to management estimates. So we could expect 1-2% impact or S$2-4m impact to distributable income per annum from increasing interest rates, which would not be material.

Sharper ESG focus in play

KIT has maintained its MSCI ESG rating of “A” in 2021, 1 notch above “BBB”, which is typically considered investment grade ESG rating, and will be looking to improve its rating further.
Two out of six directors on the Board are female, indicating 33% gender diversity in the Board.
KIT has established a dedicated Board ESG committee to oversee long-term carbon and non-carbon targets and the implementation of KIT’s sustainability strategy, in line with global best practices.
Among other targets, KIT will implement the Task Force on Climate-Related Financial Disclosures (TCFD) recommendations to disclose climate-related risks and opportunities over the next 2 years, will look to achieve 30% carbon intensity reduction by 2030 based on 2019 levels, and increase exposure to renewable energy by up to 25% of equity-adjusted AUM by 2030.
So there will continue to be more action on the renewables front in the foreseeable future, though management will need to ensure adequate returns on capital by identifying the right pockets of opportunity in an otherwise crowded renewables market.

We are hosting KIT management later today @4pm for an investor call. More updates following that. Maintain BUY, TP under review.