Citi Research analyst Brandon Lee has resumed his “buy” call on Digital Core REIT following a “period of restriction”. The analyst has also given the REIT a target price of 82 US cents ($1.10), which is down by 18% from his previous report, with a higher risk-free rate of 3.5%.
Lee’s report, dated Dec 27, comes after the REIT’s completion of its inaugural acquisition of a 25% stake in a freehold 34MW data centre in Frankfurt, Germany. The acquisition was made at a consideration of US$146 million paid via 100% debt, and resulted in a 2% distribution per unit (DPU) accretion.
“Most importantly, the acquisition opens up a new market – Frankfurt, which is one of the fastest growing data centre markets in Europe, characterized by its status as a major financial hub, central location, and availability of land,” Lee points out.
“Post the acquisition, Digital Core REIT will enjoy a higher fixed/hedged debt proportion of 64%, with higher gearing (+7 percentage points) of 33%, still within its target 35%-40% and implying $0.2 billion of debt headroom before hitting 40%,” he adds. “Should capital markets’ volatility stabilize, we expect Digital Core REIT to continue tapping into [its] sponsor’s pipeline of [over] US$15 billion for external growth.”
Digital Core REIT’s share buyback mandate, which commenced from Dec 6, 2021, is also a “positive signal”. The mandate should end in April 2023 before the REIT’s next annual general meeting (AGM). Some 9.2 million of units representing 0.8% of the REIT’s total units worth US$5.5 million or 59 US cents per share or 0.7x P/B were bought back and cancelled in December.
This move was seen as “positive” by Lee as it shows that the REIT’s valuation is undemanding. The move was also accretive to the REIT’s 1HFY2022 DPU by 0.2% and to its 3QFY2022 net asset value by 0.8%.
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The REIT is still able to buy back another 103.3 million shares worth around US$61 million before its maximum limit of 10% is breached. This will bring its gearing to around 36% versus its current gearing of 33%, notes Lee.
REIT ‘unfairly punished’
With its unit price down by 54% year-to-date (ytd), Digital Core REIT has underperformed Singapore REITs (S-REITs) in general with its -15% performance, as well as its data centre peers, Keppel DC REIT and Mapletree Industrial Trust (MINT) and -28% and -18% respectively.
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The share price underperformance has been attributed by Lee to several factors including its 100% US dollar (USD)-denominated debt structure and low fixed/hedged debt ratio, which has been raised to 64% from 50% previously. The REIT’s small market cap, poor liquidity, as well as uncertainty over US withholding tax pertaining to the sale/transfer of shares, which has since been clarified, were also factors that affected the REIT’s unit price.
In Lee’s view, the REIT has been “unfairly punished” despite its “solid execution”.
“We think Digital Core REIT’s purchase of [the] Frankfurt facility illustrates its ability to still able to execute DPU-accretive acquisitions in a tough environment, with its ongoing share buyback exercise providing a strong signal that stock is undervalued at 7.5/7.6% FY2022/FY2023 yield and 0.62x P/B,” he writes.
That said, he has cut his DPU estimates for the FY2022/FY2023/FY2024 by 3.7%/10.0%/7.4% to 3.97/4.01/4.17 US cents on higher US debt cost at 70 bps/240 bps/210 bps, mitigated by the Frankfurt acquisition.
As at 4.15pm, units in Digital Core REIT are trading 2 US cents lower or 3.77% down at 51 US cents.
