Keppel DC REIT - DBS Research 2018-12-06: On Cloud Nine

KEPPEL DC REIT (SGX:AJBU)

Keppel DC REIT - On Cloud Nine

High income visibility given limited expiries in FY19/20.
Organic growth driven by the operational ramp-up of KDC SGP 5.
Manager continues to seek acquisition opportunities in existing and new markets.
BUY call and Target Price maintained, reflective of conservative discount rates.

Trading at a yield of c.5.6-5.7%, Keppel DC REIT (KDC REIT) remains one of the few REITs in Singapore that are capable of making accretive acquisitions, supported by low cost of capital. The REIT is projected to deliver a solid 2% CAGR in distributions, with upside from acquisitions.

Our Target Price of S$1.52 is the highest in the street, after pricing in the acquisition of a 99% interest in Kingsland Data-Center (KDC SGP5) and fund raising. Our numbers could be raised by a further c.3% if the manager achieves tax transparency status for its stake in KDC SGP5, which we have not priced in.
In addition, the stock's conservative gearing of c.32% provides the REIT with amble gearing capacity to fund opportunistic acquisitions, if they arise.

3Q18 results were in line with expectations, coupled with a sustained portfolio occupancy of c.92.0% while KDC SGP 5 ramps up operationally, contributing to higher revenues in the medium term.
With limited expiries over the coming two financial years, there is high income visibility, a valued trait in the current volatile climate.

We maintain our BUY recommendation with a DCF-based Target Price of S$1.52.
Our discount rates reflect a refreshed 3.0% 10-year risk-free rate and a 50-bp increase in funding costs.

Competition from larger third-party data centre players. The data centre market is dominated by several large international operators which have been aggressively expanding into markets where KDC REIT has a presence.
KDC REIT may face higher barriers to entry and stiffer competition to attract and retain tenants.

Keppel DC REIT's 9M18 gross rental income grew by 24.7% y-o-y to S$127.5m, mainly due to the contribution from an expanded portfolio (KDC Dublin 2 and KDC Singapore 5, maincubes DC) and higher power revenue from its Singapore properties. This was somewhat boosted by the appreciation of the EUR and GBP against the SGD. This partially offset the lower revenues from Basis Bay DC and Gore hill DC due to a bulk discount provided during renewal of the latter's lease a year ago and the weakness in the AUD vs the SGD.
Other income of S$5.0m (S$2.5m higher y-o-y) due to rental top-ups partially offset lower ad hoc service and power revenues. Net property income (NPI) rose by a higher 24.6% to S$115.2m mainly on a proportionate increase in expenses (+26.0% y-o-y). On a quarterly basis, top line and net property income came in at 34% and 33.4% respectively.
Distributable income to unitholders (including capex reserves) rose 24.6% y-o-y to S$69.9m for 9M18. After stripping out these capex reserves and an enlarged equity base, DPU increased by a smaller 4.8% to 5.47 Scts (1.85 Scts, +6.3% y-o-y). This forms 74% of our full-year forecast.

Operational metrics generally improved as occupancy rate rose marginally to 93.1% (vs 92.0% in 2Q18) with a long weighted average lease expiry (WALE) of 8.5 years. We do note that for Singapore properties – Keppel DC Singapore 1 saw a slight dip due to a tenant returning space (86.6% vs 87.3% in 2Q18) but the overall impact is small. Keppel DC Singapore 5's occupancy rate improved to 84.2% (vs 73.9% in 2Q18) and has achieved its occupancy capacity for the data-centre space at the asset, with the remaining vacancy being office space which is likely to be taken up only in the medium term.
We understand that the tenant has yet to run at full force and contribution will continue to improve q-o-q as its operations are ramped up. We project Keppel DC Singapore 5 to deliver an initial yield of 7.8% when that happens from 2H19. The other data centres across its portfolio are substantially leased with a long WALE and offer strong income visibility.

The REIT’s financial metrics remain strong, with average cost of debt still stable at 1.9% with 86% of the rates fixed. The REIT will be renewing 19% (or close to c.S$130m) of loans expiring in 2019 which we believe should not be an issue to refinance.
We believe that the opportunity will be to swap the debt into a foreign currency-denominated debt (EUR or AUD), given the REIT’s diversified earnings base to achieve a better natural hedge position.

Overall gearing remained low at 32%, which empowers the REIT to acquire more assets going into 2019.
While not committing to an AUM target, the manager is reviewing opportunities in both new and existing markets as the REIT looks to bulk up and grow its distributions and AUM.

Derek TAN DBS Group Research | Mervin SONG CFA DBS Research | https://www.dbsvickers.com/ 2018-12-06

SGX Stock Analyst Report BUY MAINTAIN BUY 1.520 SAME 1.520