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Analysts retain 'buy' calls and estimates after Digital Core REIT's maiden acquisition

Felicia Tan
Felicia Tan9/23/2022 05:31 PM GMT+08  • 4 min read
Analysts retain 'buy' calls and estimates after Digital Core REIT's maiden acquisition
Analysts from DBS Group Research and UOB Kay Hian have kept 'buy' on the REIT.
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Analysts from UOB Kay Hian and DBS Group Research are positive on Digital Core REIT’s prospects after the REIT delivered on its acquisition promise.

On Sept 22, the manager of Digital Core REIT announced that it will be acquiring a data centre in Frankfurt, Germany, its first since its initial public offering (IPO). The German data centre is valued at about €558 million ($781.5 million) at 100% share.

The REIT also announced the proposed acquisition of a data centre in Dallas, Texas in the US valued at US$199 million ($281.4 million) at 100% share.

Both data centres were from the REIT’s sponsor Digital Realty.

In its statement, Digital Core REIT posited two scenarios. In the first scenario, the REIT manager said that it is looking at acquiring 25% of the Frankfurt facility, fully funded by debt. While this will increase the REIT’s portfolio by 10%, it will also increase its aggregate leverage by 7.3 percentage points to 33.0%.

The second scenario will see the REIT acquiring 89.9% of the Frankfurt data centre and 90.0% of the data centre in Dallas. This will be supported by an equity fund raising (EFR) exercise, with a mix of debt and equity funding at a ratio of 60:40. The move will grow the REIT’s portfolio size by 48%. Under this scenario, the REIT’s aggregate leverage will increase by 11.8 percentage points to 37.5%.

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While the deal is expected to be accretive to the REIT’s distribution per unit (DPU), UOB Kay Hian analyst Jonathan Koh also notes that the current market conditions are not conducive for an EFR exercise.

The analyst has kept his “buy” call with an unchanged target price of 98 US cents.

“The spirit is willing but the market is weak,” the analyst quips cleverly in his Sept 23 report.

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On this, the analyst believes scenario A will be the “most probable outcome” given the current volatile market conditions for Singapore REITs (S-REITs) and rising government bond yields.

As the steep rate hikes are expected to continue till end-2022, the analyst sees that the positive impact on Digital Core REIT’s Frankfurt acquisition may be neutralised by the steep rate hikes on Nov 2.

Despite his unchanged target price, Koh has trimmed his DPU forecast for the FY2023 by 1.5%. This comes after factoring in the REIT’s proposed acquisition under scenario A and a higher cost of debt at 3.9%.

“We expect the Fed Funds Rate to hit 4.25% by end-2022,” he writes. “Digital Core REIT’s cost of debt is expected to increase from 2.3% in 2Q22 to 3.9% in 2023.”

Like their peer, DBS Group Research analysts Dale Lai and Derek Tan have also kept their “buy” recommendation with an unchanged target price of US$1.15.

To the analysts, the REIT’s accretion levels came in slightly below their estimates.

“We have priced in an acquisition in our estimates (US$250 million, debt-funded acquisition)… The pro-forma accretion is slightly lower, largely due to the higher cost of debt of [an estimated] 3.5% (vs. 2.5% for Euro debt, in our assumptions),” they write.

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“Given the expected completion is to be in end-November 2022 at the earliest, we believe there are near-term downside risks to our FY2022 earnings,” they add.

Despite the slight downside risks, the analysts say the REIT’s earnings are underpinned by solid fundamentals; the REIT’s portfolio consists of fully occupied data centres and has a long weighted average lease expiry (WALE) of 5.5 years ensuring income stability and visibility

In addition to the booming data centre industry, annual rental escalations of 2% of the REIT’s portfolio provide for organic growth in its earnings, note DBS’s Lai and Tan.

The analysts are also positive on the REIT’s strong commitment from its sponsor, which has granted the REIT a right of first refusal (ROFR) for US$15 billion worth of data centres globally.

Plus, the sponsor has data centre developments worth a further US$5 billion that could potentially be made available to Digital Core REIT when completed. Although the cap rate spreads in the US are in the negative territory currently, Digital Core REIT could look at pipelines in Europe and Japan, the analysts write.

Unlike their peer at UOB Kay Hian, DBS's Lai and Tan believe the second scenario posited by the REIT manager will be "preferred".

This is if Digital Core REIT is able to raise equity at a unit price of at least 83 US cents, which is subject to unitholders’ approval in an extraordinary general meeting (EGM) to be called.

The analysts write: "The equity fundraising scenario is expected to generate a DPU accretion of 3.1% – this could potentially be higher if the placement is done at a higher price. Every 1 US cent difference in the EFR price will drive accretion by +/- 20 basis points."

Units in Digital Core REIT closed 2 US cents lower or 2.53% down at 77 US cents on Sept 23.

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