DBS maintains 'buy' call on Digital Core REIT despite h-o-h lower DPU of 1.92 US cents

Nicole Lim
5-min read

DCREIT’s healthy gearing, ample debt headroom, and its trading at a yield of more than 7.1% are positives to DBS analysts.

“Attractive valuations and near-term catalysts'' have led the analysts at DBS Group Research to maintain their “buy” call for Digital Core REIT (DCREIT), with an unchanged target price of 90 US cents ($1.20).

One of the near-term catalysts identified by analysts Dale Lai and Derek Tan is the REIT’s recent acquisition of the data centre in Frankfurt.

“DCREIT has recently completed the acquisition of a 25% stake in the Frankfurt data centre (DC), which is expected to drive an accretion of [around] 2.0%,” note the analysts, who add that the REIT has the option to increase its stake in the Frankfurt DC, as well as other pipeline assets from its sponsor, which will further drive earnings.

“This will enable DCREIT to continue acquiring accretive data centre assets going forward,” they write.

In addition, the income contribution from the 25% stake in the Frankfurt DC helped to maintain the REIT’s distributable income and DPU, add the analysts.

In their July 28 report, Lai and Tan are positive on the pure-play data centre REIT, which is currently riding on structural tailwinds.

“Demand for data centres in key markets remains robust with the lack of available capacity. DCREIT’s presence in some of these key markets throughout the US, Canada, and Europe means it continues to benefit from such robust demand,” say Lai and Tan.

“Moreover, the long weighted average lease expiry (WALE) for its assets ensures income stability in the foreseeable future. In the event of any availability, DCREIT should be able to quickly backfill the space, given the healthy demand dynamics in those markets,” they add.

Lai and Tan’s report follows the REIT’s 1HFY2023 ended June results which saw a 6.8% drop in its distribution per unit (DPU) of 1.92 US cents from 2.06 US cents a year ago.

The REIT’s revenue for the 1HFY2023 rose by 1.1% y-o-y but fell by 2.7% h-o-h to US$53.4 million. Net property income (NPI) grew by 0.7% y-o-y and 3.5% h-o-h to US$35.1 million.

However, the REIT’s DPU of 1.92 US cents stood flat h-o-h, which is in line with the analysts’ projections, forming about 52% of their FY2023 DPU projections.

The REIT’s overall portfolio occupancy declined marginally from 96.9% to 96.7% q-o-q, due to the slight decline of 2.1% in occupancy at the Toronto DC. However, the analysts say leasing activity in Frankfurt remains robust, and they expect to see an improvement in the Frankfurt DC’s occupancy rate in the next quarter.

Tan and Lai note that there were no new leases signed or renewed in 2QFY2023, and 2% of DCREIT’s portfolio leases by rent remain to expire in FY2023.

The analysts also note that transactions involving data centres remained limited in the past six months. As interest rates remain high and continue to creep up, DCREIT’s portfolio cap rates could see a marginal expansion by the year end, they add.

DCREIT’s borrowing costs also increased by 60 basis points (bps) q-o-q to 4.7%, due to the re-contracting of an interest rate swap during the quarter. No loans were refinanced in 1HFY2023, and borrowing hedged to fixed rates remained at 72%. In addition, no refinancing is required until FY2025.

Its year-to-date average cost of debt is about 4.4%, in line with the management’s guidance of maintaining borrowing costs of 4.5%-5% in FY2023, while gearing remains “healthy” at 34.2%.

As DCREIT has been granted a right of first refusal (ROFR) by its sponsor for data centre assets in its pipeline valued at up to about US$15 billion, the analysts say that this allows the REIT to potentially grow into the largest pure-play data centre Singapore-REIT (S-REIT).

“Its healthy debt headroom provides it the financial flexibility to embark on further accretive acquisitions. We believe that once markets become more conducive for further acquisitions, DCREIT will be able to grow further.” they add.

Finally, there are no further updates on Cyxtera’s Chapter 11 proceedings, note the analysts.

“Operationally, DCREIT’s performance remains stable with only two vacancies within its portfolio (Toronto and Frankfurt). Although leasing momentum seems to have slowed down in Toronto, we believe the increased enquiries in Frankfurt will help pick up the slack. Moreover, supply in Toronto remains tight and rents have been holding out. Although the 60 bps increase in borrowing costs this quarter will have an impact, we believe that financing costs will hover around current levels, as there are no refinancing requirements until FY25, and the majority of loans remain on fixed rates.” the analysts conclude.

The analysts believe that DCREIT is currently trading at a very attractive yield of more than 7.1% and at a P/B multiple of 0.65 times, which is “almost unheard of for a pure-play data centre REIT”.

Despite the ongoing uncertainties surrounding its leases with Cyxtera, Tan and Lai believe a resolution will soon be reached and the REIT will be able to deliver their projected earnings.

DCREIT’s share price has recovered over the past month, and it could potentially be included in the FTSE NAREIT Developed Asia Index as soon as September 2023, they say.

As at 4.04pm, units in Digital Core REIT are trading flat at 50 US cents.

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