Income stability, visibility and a deep growth pipeline
With its US$990 million ($1.33 billion) IPO last December heavily subscribed, Digital Core REIT (DC REIT) was also one of the better-performing new issues for 2021, ending the year at 32% above its IPO price of US$0.88 ($1.18). It closed on Jan 24 at US$1.18.
Investors like DC REIT for its profile as a REIT for data centres, which are characterised by long leases and blue-chip tenants with big names in the tech industry and underpinned by long-term growth in demand. In addition, its sponsor, Digital Realty Trust, a leading data centre player, has not just the bulk in terms of its existing pipeline and portfolio, but also access to cutting-edge and environmentally-friendly processes.
For instance, Digital Realty has access to liquid cooling systems which are preferred for edge computing. It has implemented over liquid-cooled bare metal servers at its data centre in Singapore, although the facility is not part of DC REIT. Air cooling is unsuitable for edge deployments located in urban environments because of pollution, experts say.
In addition, DC REIT’s weighted average lease expiry (WALE) of 6.2 years provides income stability. The good thing for DC REIT is that it has very sticky customer relationships, as its top six tenants are Digital Realty’s long-standing customers of more than 15 years, with a high tenant retention rate of 95.8%.
John Stewart, CEO of DC REIT’s manager, reckons that customers tend to stay because of high capex and high switching costs. “We see no reason to expect that these customers will not continue to renew. These are mission-critical business applications and they are very healthy customers with actively deployed workloads.”
Typically rising interest rates raise risk-free rates and REITs take their pricing off risk-free rates via a yield spread. Hence, unit prices usually fall to maintain the yield spread. However, DC REIT is trading at a yield of over 4%. At this price, DC REIT would be able to make yield-accretive acquisitions as capitalisation rates of data centres are at the 5%–5.6% range.
At 27%, DC REIT’s gearing is lower than the S-REIT average of 37%, giving a debt headroom of US$424 million. Sponsor Digital Realty has granted DC REIT a global right of first refusal (ROFR) on its growing data centre pipeline worth over US$15 billion.
In addition, the REIT’s sponsor has a further US$5 billion worth of data centre developments that could potentially be made available to the REIT when completed.
DC REIT is projecting a distribution yield of 4.75% for FY2022 and DPU growth of 5.26% from FY2022 to FY2023.
In a Dec 7, 2021, report, UOB Kay Hian analyst Jonathan Koh says that the REIT derives 68.5% of its base rental income from what is known as “hyperscalers”, which means tech giants such as Amazon, Facebook, Google, IBM and Microsoft.
Koh points out that demand for hyperscale data centres is projected to grow at a CAGR of 23% in 2020–24, outpacing a CAGR of 15% for the broader North America data centre market.
In their Jan 14 report, DBS Group Research analysts Dale Lai and Derek Tan, who have a “buy” call and US$1.40 target price, assumed the REIT’s manager will make acquisitions totalling US$750 million over the next two years, which can drive a three-year DPU CAGR of 7% for FY2021–FY2024, which is around 10% above the IPO forecast.
They reiterate its long WALE and also how it enjoys annual rental escalations of around 2% for its portfolio, which provides for organic growth in its earnings.