Analysts from Citi Research and DBS Group Research remain upbeat on Digital Core REIT (DCREIT) despite the 1HFY2024 results ended June 30, which saw a 6.3% y-o-y decline in distribution per unit (DPU) of 1.80 US cents (2.42 cents).
Citi’s Brandon Lee keeps his “buy” call with a target price of 70 US cents, and DBS’s Dale Lai and Derek Tan keep their “buy” call with a target price of 75 US cents.
Lee from Citi says that the 1HFY2024 result was “a slight beat”, as loss of contributions from two data centres divested in Silicon Valley, higher debt expenses and expanded share base were mitigated by acquisitions, annual rental escalations and higher income from 371 Gough Road.
On a same-store basis, cash NPI was up 1% y-o-y, gearing rose 0.8% percentage points (ppts) to 34.4% due to additional debt assumed on acquisitions, while debt cost for the quarter improved 70 basis points (bps) to 4.1%.
The analyst cites positives for the REIT in this quarter. It saw portfolio occupancy improving 1.2% pts q-o-q to 96.6% mainly helped by Frankfurt DC’s 6.3% pts to 98.5% as several new tenants were signed at positive cash reversion, including a new customer which leased 1.5 megawatt (MW) and 100% retention for the space previously occupied by its second largest customer.
In LA, DCREIT is making good progress on the two assets whose leases will expire on Sept 30 and expects to outperform its underwriting assumptions, accompanied by double digit positive reversions with occupancy expected to hit 50% on Oct 1 and 80% within 18 months, Lee says.
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“Cap rates are more likely to go down than up, as the private market remains active in sourcing data centres. On share buybacks, DCREIT will take opportunities as they come, but is limited by creep rule and limited float,” he adds.
Some negatives weigh on Lee’s mind: For one, the sole tenant at the fully fitted data centre in Northern Virginia, US, will likely not exercise its renewal o[tion and exit the property upon its existing lease expiry on June 30, 2025 due to its larger requirement of 100MW. This tenant contributed 15%/11% to asset under management/annualised rent with an IT load of 8.6MW for DCREIT.
Lee notes that the REIT says that downtime should be manageable and positive reversions should be achievable. Meanwhile, in Toronto, the 371 Gough Road’s occupancy fell 1.2% pts q-o-q to 65.6% due to a loss of tenants with the market remaining soft.
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Lee’s target price of 70 US cents is based on the average discount dividend model (DDM) and a revised net asset value (RNAV) valuations.
“Sharp rise in interest rates could increase the cost of debt and hence lower DCREIT’s DPU while raising its cost of capital for potential acquisitions,” says Lee. “Meanwhile, a relatively high degree of customer concentration could impact cash flow if a major lease is not renewed, and the REIT also has higher than expected capex requirements. If any of these risk factors has a greater downside impact than we anticipate, the share price will likely have difficulty attaining our target price.”
Likewise, Lai and Tan from DBS note that demand for data centres in key markets remains robust with the lack of available capacity.
They also cite the recent acquisition of Frankfurt DC and Osaka DC to drive earnings, noting that DCREIT has the option to increase its stake in Frankfurt DC as well as other pipeline assets from its sponsor.
The analysts note that DCREIT has been granted a right of first refusal by its sponsor for data centre assets in its pipeline valued at up to US$15 billion. This allows DCREIT to potentially grow into the largest pure-play data centre S-REIT.
Meanwhile, Dale and Lai highlight the recent resolution of Cyxtera’s bankruptcy issues, which they say now positions DCREIT to be able to return to stable earnings, with some organic growth income anticipated in the coming quarters.
Like Lee, they highlight that the upcoming expiry of master leases at the two LA properties in 4Q2024 may introduce some earnings volatility, but given the sustained strong demand and the successful signing of leases directly with several of the underlying tenants, they believe that DCREIT is well on track to achieve an underlying occupancy of at least 50% for both LA properties.
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Key risks for the DBS analysts include slowdown in demand for data centres or decline in rents in North America, where the bulk of the REIT’s portfolio is located.
They keep their “buy” with a target price of 75 US cents based on a discounted cash flow valuation with a weighted average cost of capital of 6.2%.
As at 11.16am, units in Digital Core REIT are trading 2.5 US cents lower or 4.032% down at 59.5 US cents.
