Analysts from DBS Group Research and CGS-CIMB Research have maintained their “buy” and “add” calls for Keppel DC REIT with lower target price (TPs) of $2.20 and $2.12.
DBS’s Dale Lai and Derek Tan believe the REIT’s “prudence” in the past will pay off as it continues to deliver acquisitions ahead of expectations.
Their discounted cash flow (DCF) based target price has been revised lower to $2.20 on lower DPU estimates, and assuming a weighted average cost of capital (WACC) of 6.4% at a risk free rate of 3.5% — and without factoring in any further acquisition assumptions.
Amid record low cap rates for data centres globally, Keppel DC REIT continues to deliver acquisitions that are accretive to distribution per unit (DPU), they say.
The analysts point out that following acquisitions in Amsterdam, Guangdong and London in FY2021, the REIT has just announced another two in Guangdong valued at more than $320 million. “These accretive acquisitions should add to earnings in addition to organic growth within its existing portfolio,” say Lai and Tan.
Meanwhile, CGS-CIMB’s Lock Mun Yee says that while some Singapore REIT (S-REIT) managers have turned cautious towards acquisitions, Keppel DC REIT has been undeterred by the higher interest rate environment and continues to evaluate off-market deals that would provide higher yields.
See also: Test debug host entity
“Future acquisitions are not limited to China as Keppel DC REIT intends to maintain a diversified portfolio, with exception of its overweight position in Singapore, which will remain a core market,” she says.
The REIT’s gearing increased 2.2 percentage points (ppt) q-o-q to 37.5% following its acquisition of Guangdong DC2 and DC3. “The manager intends to amalgamate acquisitions, letting gearing trend towards its internal limit of 40% before tapping equity markets to de-leverage the portfolio. 74% of Keppel DC REIT’s borrowings are at fixed rates,” says Lock, adding that its average cost of debt increased from 1.8% as at 1QFY2022 to 2.0% for 9MFY2022.
According to the analyst, Keppel DC REIT is trading at an attractive 5.8% FY2022 DPU yield at a 1.3x price-to-net-asset-value ratio (P/NAV). Lock has kept her FY2022 to FY2024 DPU estimates unchanged and rolled forward her estimates to FY2025. Her dividend discount model (DDM) based TP has decreased from $2.63 to $2.12 on account of a higher risk-free rate from 1.6% to 2.9% and the increase of cost of equity capital (COE) from 6.6% to 7.7%.
See also: Maybank downgrades ComfortDelGro in contrarian call over Addison Lee acquisition worries
Lock says the REIT’s portfolio reconstruction is paying off, with the REIT’s 3QFY2022 DPU of 2.585 cents in line with 25.5% of her forecast for FY2022, and its 9MFY2022 DPU reaching 75.2% of the same forecast.
She believes this DPU growth will be protected by Keppel DC REIT’s 90% hedge on foreign-sourced distributions until end-2023, which provides income stability that can mitigate inflation and market volatility.
The REIT’s 3QFY2022 and 9MFY2022 revenue rose 1.4% and 0.5% y-o-y to $70.3m and $64.1m respectively due to contributions from Guangdong DC 1, 2 and 3, Intellicentre 3 and asset enhancement initiatives and positive reversions and rental escalations, says Lock.
She notes that these improvements were partially offset by higher utilities cost at the Singapore colocation assets, depreciation of EUR, AUD and GBP and an absence of income following
the divestment of iSeek DC.
Lock says the REIT has entered into 2-year fixed rate electricity contracts for its Singapore colocation assets, which will commence in January 2023. “While net dollar retention (NDR) prevents Keppel DC REIT from sharing the fixed rates, we understand that the rates are higher than the current discounted floating rates for its existing contracts.”
“Nonetheless, Keppel DC REIT is able to pass through more than 90% of the electricity costs to its tenants and is unaffected by higher electricity cost for its master leases as clients contract electricity directly with the power suppliers,” she adds.
The way Dale and Lai of DBS see it, despite near-term challenges on the horizon, the REIT’s fundamentals are still positive. “Higher utility costs and rising interest rates pose near-term risks to Keppel DC REIT’s earnings. Although accretion from recent acquisitions have been eroded by higher operating costs, we believe the bulk of the impact is already factored into the current share price,” explain the analysts.
For more stories about where money flows, click here for Capital Section
“Going forward, growing demand for data centres and positive fundamentals in the sector will help Keppel DC REIT return to its organic growth path,” they add.
They believe that market dynamics are supportive of further growth for the REIT, whose current portfolio occupancy of more than 98% is the highest since its initial public offering (IPO) in 2014. “The continued strong demand for data centre capacity amid the prolonged Covid-19 outbreak and rise of the digital economy would support higher occupancies and revenues across its portfolio in the foreseeable future,” say the analysts.
They say that Keppel DC REIT’s foreign exchange (FX) hedging policies and high degree of interest rate hedges have shielded it from the recent interest rate spikes and FX volatility. “Although KDCREIT has been mostly shielded from such headwinds in the near term, they could face some pressure in the longer term. With interest rates looking to continue rising and foreign currencies expected to remain depressed against the SGD, we believe there could be some downside risks in the coming years,” add Dale and Lai.
Their risks include competition from larger third-party data centre players as the REIT may face higher barriers to entry and stiffer competition from international operators or funds that are
also looking to grow their footprint and attract tenants.
For Lock, her downside risks include a softening of data center demand which could affect reversions and ability to structure in rental escalation, larger-than-expected costs from higher electricity prices eroding earnings and higher interest rates and cost of capital which could price out acquisitions, eroding earnings and slowing KDC’s inorganic growth momentum.
As at 11.00am, shares in Keppel DC REIT were trading 5 cents or 2.76% up at $1.86.
