Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Brookfield Infrastructure Corporation (NYSE:BIPC) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Brookfield Infrastructure Carry?
The image below, which you can click on for greater detail, shows that at December 2023 Brookfield Infrastructure had debt of US$12.1b, up from US$4.68b in one year. However, because it has a cash reserve of US$577.0m, its net debt is less, at about US$11.6b.
How Healthy Is Brookfield Infrastructure's Balance Sheet?
According to the last reported balance sheet, Brookfield Infrastructure had liabilities of US$6.36b due within 12 months, and liabilities of US$13.5b due beyond 12 months. On the other hand, it had cash of US$577.0m and US$2.18b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$17.1b.
The deficiency here weighs heavily on the US$4.88b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Brookfield Infrastructure would probably need a major re-capitalization if its creditors were to demand repayment.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Weak interest cover of 2.4 times and a disturbingly high net debt to EBITDA ratio of 5.7 hit our confidence in Brookfield Infrastructure like a one-two punch to the gut. The debt burden here is substantial. The good news is that Brookfield Infrastructure grew its EBIT a smooth 30% over the last twelve months. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Brookfield Infrastructure can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Brookfield Infrastructure's free cash flow amounted to 31% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Our View
On the face of it, Brookfield Infrastructure's net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. It's also worth noting that Brookfield Infrastructure is in the Gas Utilities industry, which is often considered to be quite defensive. Looking at the bigger picture, it seems clear to us that Brookfield Infrastructure's use of debt is creating risks for the company. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. 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. We've identified 4 warning signs with Brookfield Infrastructure (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.