Analysts from CGS International (CGSI) and OCBC Investment Research (OIR) are somewhat positive over Keppel DC REIT’s move to enter into Japan, which is the second largest data centre market in Asia. This comes after the mixed outlook by analysts from Citi Research and UOB Kay Hian, who gave the REIT “buy” and “hold” calls respectively. Citi kept its target price of $2.07 while UOB Kay Hian upped its target price to $1.98.
Keppel DC REIT’s manager, on July 11, announced that Keppel DC REIT and Keppel have agreed to acquire a 100% interest in a shell and core data centre located in Tokyo for JPY23.4 billion ($201.0 million). The total purchase consideration represents a discount of 2.5% to the property’s valuation of JPY24.0 billion. Keppel DC REIT will have an effective interest of 98.47% in the property while the remaining 1.53% will be held by Keppel.
This time, the analysts from CGSI and OIR have kept their “hold” calls but with higher target prices of $1.99 and $1.97 from $1.88 and $1.74 respectively.
“In a call with analysts, management shared that the entry cap rate was 3% based on in-place rents, which are 10% - 15% below market rents. Taking into consideration market rents, the hypothetical cap rate, based on the acquisition price, would be 3.5%, management said,” say CGSI analysts Natalie Ong and Lock Mun Yee. The acquisition is slated to be completed in 2Q2024.
While Ong and Lock note that the distribution per unit (DPU) accretion from the Tokyo data centre acquisition is “mild”, they add that the REIT’s entry into Japan presents “an exciting new geography for inorganic growth”. That said, future acquisitions will have to be paid by proceeds from asset divestments or equity fund raisings, given that Keppel DC REIT’s debt headroom of 40% gearing has been utilised.
The current acquisition will be fully funded with fixed and floating JPY debt. As such, the REIT’s aggregate leverage will increase to 39.4% from 36.2% on a pro forma basis. Its average cost of debt will, however, improve to 3.3% from 3.6% previously.
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“While asset spreads are still positive for Japanese assets, [the Tokyo data centre]’s mild DPU accretion of 1.1% was only possible by fully debt-funding the acquisition (lowest cost of capital),” the analysts note.
Given the tight data centre market in Tokyo, the analysts see positive reversions to be possible upon the lease renewal. The lease agreement for this data centre was signed in mid-2010 and will expire in seven years.
The tenant at the data centre is a Fortune Global 500 company and is one of Keppel DC REIT’s top 10 tenants by gross rental income prior to the data centre acquisition, the analysts note.
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To this end, the analysts have increased their DPU estimates for FY2024, FY2025 and FY2026 by 0.2%, 0.9% and 0.7% respectively thanks to the Tokyo data centre acquisition.
“Keppel DC REIT’s FY2024 DPU yield of 4.5% is -0.6 standard deviations (s.d.) from its historical average and appears fair, in our view,” write Ong and Lock.
However, the analysts have retained their “hold” call due to the lack of catalysts and the lack of clarity on the resolution for the REIT’s tenant, Bluesea.
Meanwhile, the OIR research team sees room for positive rental reversions but only over the medium term.
“We believe near-term growth would be limited as the lease does not come with annual rental escalations and there are still approximately seven years remaining on the lease term,” the team notes. “However, over the medium term, there is room for a potential rental uplift, given that the passing rent of the property is 10% - 15% below market rents, coupled with positive supply and demand dynamics in the market.”
Like its peers at CGSI, the OIR team likes the REIT’s diversification into another core data centre market, which will help lower its portfolio exposure to China. However, the higher aggregate leverage ratio increases the changes of an equity fund raising exercise, it adds.
OIR’s higher target price is due to a higher terminal growth rate assumption of 2.0% from 1.25% previously given the “robust secular growth prospects of the data centre industry” as well as the potential expansion in this new market. Both factors will benefit the REIT, OIR’s team notes.
Units in Keppel DC REIT closed 4 cents lower or 2.01% down at $1.95 on July 15.
