UOB Kay Hian analyst Jonathan Koh has kept his “buy” call on Keppel DC REIT (KDC REIT) as he sees green shoots of recovery for the REIT’s Guangdong data centre 1 (DC1) and 2 (DC2) from generative artificial intelligence (AI) applications in China.
In his June 11 report, Koh notes that there has been a frenzy for gen AI in China with companies like Baidu, Alibaba and Tencent developing gen AI and large language models (LLMs) in the country; these companies have already launched their chatbot, which is similar to OpenAI’s ChatGPT. China also has four newly minted gen AI unicorns, Zhipu AI, Moonshot AI, MiniMax and 01.ai.
As at the date of his report, Koh adds that the Cyberspace Administration of China has approved 117 gen AI models for use by the public as of April.
“The government in Beijing has provided policy support through funding, tax subsidies, eco-system development and infrastructure,” he says.
Furthermore, China companies like Huawei and Shanghai Biren Intelligent Technology are producing AI processors, which will accelerate the growth of gen AI in the country.
With Guangdong DC tenant Bluesea Development refocusing on the wholesale and hyperscale market, the REIT has worked with Bluesea to submit proposals to requests from potential tenants such as domestic hyperscalers, e-commerce players, social media apps and cloud service providers, as well as AI start-ups.
“Successful bids could substantially backfill the vacant space at Guangdong DC1 and DC2,” Koh writes.
He adds that KDC REIT is working on a recovery roadmap and leasing pipeline with Bluesea. So far, it has recognised a loss allowance of $5.3 million for uncollected income from the Guangdong DCs, which have a negative impact of 0.326 cents or 13% to the REIT’s distribution per unit (DPU) for the 1QFY2024.
“We expect the loss allowance to be recognised till 1HFY2025. New tenants could start to contribute in 2HFY2025,” notes Koh.
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As the analyst expects the REIT to see recovery from Guangdong DC1 and DC2, he has raised his DPU forecast for the FY2026 by 3%.
His target price has also been lifted to $2.20 from $2.15. Koh’s new target price is still based on a dividend discount model (DDM) where the cost of equity (COE) is 6.75% and a terminal growth of 2.5%.
Looking ahead, Koh expects KDC REIT to look for acquisition opportunities in Singapore and Japan after its aggregate leverage is expected to be lowered by 0.8 percentage points (ppts) to about 36.8%. The lowered figure is due to the divestment of Intellicentre Campus in Sydney in April. The campus was divested for A$174.0 million ($152.1 million). KDC REIT will re-invest A$90 million of the proceeds into an Australian data centre note issued by Macquarie Data Centres Group Pty Ltd and guaranteed by Macquarie Technology Group.
In Singapore, KDC REIT has the opportunity to tap on the pipeline of data centres held by its sponsor, Keppel.
Keppel and Singapore Press Holdings (SPH) established a 60:40 joint venture (JV) to develop a campus for three data centres at 82 Genting Lane. The first phase, Keppel DC SGP 7, is a colocation data centre with a gross floor area (GFA) of 185,463 sq ft. SGP 7 is fully committed and all of its tenants have moved in in the 1H2024.
“We expect KDC REIT to acquire SGP7 in due course as Singapore is its preferred market,” says Koh.
In Japan, the analyst expects KDC REIT to leverage on its local partner, Mitsui Fudosan, in sourcing for deals. Keppel signed a memorandum of understanding (MOU) with the latter to jointly explore data centre development in Japan and Southeast Asia.
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The Keppel Data Centre Fund II also has a framework agreement with Mitsui Fudosan for the forward purchase of a data centre currently being developed in Western Tokyo.
Another plus for KDC REIT is the lower Euribor.
“Euro-denominated debts accounted for a sizeable 39% of KDC REIT’s total borrowings. KDC REIT has 11% of total borrowings maturing in 2024 and 2025, which are mostly denominated in Euro and on floating interest rates (not hedged),” notes Koh.
“Thus, KDC REIT benefits as the European Central Bank has cut the interest rate on its main refinancing operations by 25 basis points (bps) to 4.25%. The bulk of KDC REIT’s borrowings mature in FY2026 and beyond,” he adds.
Units in KDC REIT closed flat at $1.79 on June 12.
