UOB Kay Hian analyst Jonathan Koh has initiated coverage on Keppel DC REIT with a “buy” call with a target price of $2.10.
Keppel DC REIT is a pure play on data centres in Asia Pacific (APAC) and Europe and is set apart from the rest of the data centre REITs by its focus on colocation data centres.
Colocation data centres account for about 65% of the REIT’s rental income and provide stronger positive rental reversion, which stood at mid-to-high single digits in the 3QFY2023 ended Sept 30, 2023, says Koh.
Master leases for Keppel DC REIT’s fully-fitted, shell and core data centres have built in rental escalations at 2% to 4% per year.
The REIT also has a solid track record for growing through acquisitions. Since its listing in December 2014, the REIT’s portfolio has expanded by 3.7 times. Furthermore, it has a pipeline of potential acquisitions for data centres that are under development and managed by sponsor Keppel’s private data centre funds worth more than $2 billion.
The potential pipeline includes three data centres in Singapore and a “sizeable pipeline” from tier one cities in China. Keppel DC REIT also has the right of first refusal (ROFR) to acquire Almere DC 2 in The Netherlands to expand its presence there, where its existing Almere data centre is located.
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Besides the Netherlands, Keppel’s private data centre funds also have investments in Sydney, Australia and Jakarta, Indonesia.
AI has potential to boost demand in medium-term
The burgeoning artificial intelligence (AI) landscape has the latent potential to boost demand for the REIT in the medium term.
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“AI is computationally intensive. As an illustration, a ChatGPT search requires 10 times more compute cycles than a Google search. Generative AI models could be up to 100 times bigger than standard AI models. We are still in the early stage of development for AI. Eventually, AI would become more deeply integrated into our daily lives,” says Koh.
Guangdong Bluesea Data Development updates
On Dec 15, Keppel DC REIT announced that it has issued a letter of demand (LOD) to its tenant Guangdong Bluesea Data Development to recover arrears of RMB48.3 million ($9.1 million) in relation to Guangdong DC1, DC2 and DC3.
DC1 serves two telco operators and occupancy has stabilised at 70% - 80% while DC2 is ramping up occupancy. It has secured a new telco tenant and occupancy is low at 30%, says Koh.
“We have assumed occupancies at DC1 at 75% and DC2 at 30% after Keppel DC REIT established direct relationships with the three state-owned telco operators,” he writes.
Dividend yield
Based on the analyst’s estimates, Keppel DC REIT provides a FY2024 distribution yield of 5.0% and P/NAV of 1.33 times, which is higher than its past yields. “Its yield spread is 2.1% above the Singapore 10-year government bond’s yield of 2.9%,” says Koh.
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He adds that the REIT’s valuation is at a slight premium compared to its domestic peers but represents a significant discount against its peers in APAC and the US.
Koh’s target price is based on the dividend discount model with a cost of equity (COE) of 6.75% and risk-free rate of 2.75%. Its equity risk premium is at 5.0%. Koh has also modelled his target price based on a conservative beta of 0.8 times and terminal growth rate of 2.5%.
Units in Keppel DC REIT closed flat at $1.85 on Jan 11.
