DIGITAL CORE REIT (SGX:DCRU)
Digital Core REIT - 1Q22 Bridge Over Troubled Waters
- Digital Core REIT’s 1Q22 results were in line with expectations with all 10 data centres remaining fully occupied. Digital Core REIT has hedged 50% of its borrowings to fixed interest rates. Assuming the Fed Funds Rate averages 2.5%, we estimate Digital Core REIT’s average cost of debt would increase to 3.2% in 2023.
- We trim our 2023 DPU forecast by 9%. Digital Core REIT provides a distribution yield of 4.6% for 2023 (Keppel DC REIT (SGX:AJBU): 4.9% and Mapletree Industrial Trust (SGX:ME8U): 5.6%). Downgrade to HOLD. Target price: US$1.10.
Digital Core REIT's 1Q22 Results
- Digital Core REIT (SGX:DCRU) reported distributable income of US$12.1m, which is 1.9% above forecast and in line with our expectations.
- Portfolio remains resilient. Occupancy rate for all 10 data centres remains at 100%. Digital Core REIT has long WALE of 5.5 years.
- Conservative level of gearing. Digital Core REIT has total debt outstanding of US$350m and aggregate leverage is low at 26%. Its debt headroom based on aggregate leverage of 35% is US$188m. Its weighted average debt maturity is 4.7 years.
- Hit by rising cost of debt. Digital Core REIT has entered into US$175m interest rate swap to hedge 50% of its borrowings to fixed interest rates. Its cost of debt is expected to increase from 1.2% in 1Q22 to 2.1% in 2Q22. Management estimated that every 50bp increase in interest rates will reduce distributable income by US$700,000 per year. Assuming that the Fed Funds Rate averages 2.5%, we estimate that Digital Core REIT’s average cost of debt will increase to 3.2% in 2023.
- Unexpected tenant bankruptcy. Digital Core REIT’s 5th largest tenant, a privately held IT service provider, has filed for bankruptcy protection. The tenant occupies 2.7MW or one-third of the capacity for its data centre in Toronto. It accounted for US$5m or 7% of Digital Core REIT’s annualised revenue. The tenant remains current on its rental obligations.
- Sponsor provides bridge over troubled waters. Sponsor Digital Realty and Digital Core REIT have reached an agreement for Digital Realty to guarantee the rental income stream in the event of cash flow shortfall due to the customer bankruptcy. Thus, the customer bankruptcy is not expected to have a material impact on Digital Core REIT’s DPU.
- Strong demand for data centre space in Toronto. Management expects the capacity to be backfilled as vacancy had tightened in 2H21. Pricing on a wholesale and hyperscale basis had increased 6% and 5% respectively to US$175/kW/month and US$105/kW/month in 2021. Toronto has limited new supply of data centres due to scarcity of available land in preferred locations.
- Insulated from variation in price of electricity. All lease contracts are structured with energy costs 100% reimbursed by customers. 63% of its leases by net rentable sf (NRSF) are on a triple net structure, whereby real estate taxes and property expenses are absorbed by tenants.
Focus on top-tier core markets.
- Digital Core REIT invests in a diversified and stabilised portfolio of mission-critical data centres. Its portfolio comprises 10 freehold data centres concentrated within top-tier markets in the US (North Virginia, Silicon Valley and Los Angeles) and Canada (Toronto) with an appraised valuation of US$1.4b and NRSF of 1.2m. These core markets have concentrations of large blue chip customers with a diverse range of mission-critical demand. Northern Virginia and Silicon Valley, which are the largest data centre markets in the US, accounted for 77% of its AUM.
Able to scale up rapidly due to sizeable sponsor pipeline.
- Sponsor Digital Realty is the largest global provider of cloud-and carrier-neutral data centres, colocation and interconnection solutions. It has a network of 291 data centres with net rentable square feet (NRSF) of 35.8m sf across 47 metropolitans in 24 countries on six continents. Digital Core REIT is the exclusive S-REIT vehicle of Digital Realty. The sponsor has granted Digital Core REIT a global right of first refusal (ROFR) on its growing data centre pipeline worth over US$15b (existing: US$10b, under construction: US$5b).
- Pursuing acquisitions to enhance geographical diversification. We expect Digital Core REIT to focus on stabilised data centres in developed markets. It will explore acquisition of data centres in Asia Pacific (Singapore and Australia) and Europe (France, Germany, Netherlands and the UK) from its sponsor pipeline. Digital Realty owns 75 data centres in these preferred markets that will enhance Digital Core REIT’s geographical diversification.
Digital Core REIT - Earnings forecast revision & recommendation
- We trim our 2023 DPU forecast for Digital Core REIT by 9% due to the higher cost of debt.
- Downgrade to HOLD. Our target price for Digital Core REIT of US$1.10 is based on DDM (cost of equity: 5.75%, terminal growth: 2.0%).
- Pure play on data centre. Digital Core REIT provides a distribution yield of 4.6% for 2023 Keppel DC REIT (SGX:AJBU): 4.9% and Mapletree Industrial Trust (SGX:ME8U): 5.6%). It deserves to trade at a premium due to its status as a pure play on data centres with acquisition-led growth supported by Digital Realty.
- See
- Catalysts:
- Organic growth from cash rental escalation of 1-3% (weighted average: 2%).
- Yield-accretive acquisitions tapping on its sponsor’s large and growing data centre pipeline.
Jonathan KOH CFA
UOB Kay Hian Research
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https://research.uobkayhian.com/
2022-04-22
SGX Stock
Analyst Report
1.10
DOWN
1.320
