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DBS keeps 'buy' call on Keppel DC REIT even with Guangdong tenant's overhang (update)

The Edge Singapore
The Edge Singapore  • 4 min read
DBS keeps 'buy' call on Keppel DC REIT even with Guangdong tenant's overhang (update)
Keppel DC REIT's data centres in Guangdong / Photo: Keppel DC REIT
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Keppel DC REIT's 1QFY2024 distribution per unit of 2.192 cents was in line with the expectation of DBS Group Research, which has kept its "buy" call and $2.20 target price.

In a business update on April 19, the REIT's portfolio occupancy held steady at 98.3%, and positive rent reversions and rental escalations continued to drive organic revenue growth. 

The 1QFY2024 DFPU of 2.192 cents was up 19.1% over the preceding 4QFY2023, thanks to the recognition of approximately $2.8 million from the settlement sum from a tenant DXC. 

Keppel DC REIT plans to recognise the full sum of $11.2 million over the four quarters of FY2024.

Also, just three months of loss allowance due to the absence of income from Guangdong DCs (compared to the recognition of 5.5 months in 4Q23) was recognised, notes DBS.

Gearing and all-in borrowing costs, meanwhile, remained stable at 37.6% and 3.5%, respectively.

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DBS warns that the ongoing concerns regarding key tenant Bluesea's leases at the Keppel DC REIT's Guangdong data centre will result in a "significant overhang" as rental payments continue to be missed. 

On the other hand, the settlement sums of $11.2 million from DXC offer some relief, partially mitigating the income loss from the Guangdong DCs. 

"Despite these challenges, core DPU, excluding adjustments, would have remained relatively stable y-o-y based on our estimates. 

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"We anticipate that positive rental reversions and escalations will help counterbalance the impact of higher financing costs and less favourable FX hedges this year," adds DBS.

DBS says it has already assumed no income contribution from Guangdong this year. "Any positive developments in this regard would be considered an upside to our estimates," says DBS.

The research team at OCBC Investment Research (OIR) has also kept its "buy" call on Keppel DC REIT even though uncertainties over the REIT's China operations remain.

The situation with Bluesea in China could take 12 to 24 months for the recovery roadmap to pan out, notes the team. The REIT is also likely to see an operating loss should it try to take over the space, it adds. With that in mind, Keppel DC REIT will keep the master lessee for now.

Keppel DC REIT's 1QFY2024 DPU also stood "slightly below" the team's expectations at 23.3% of its initial FY2024 forecast.

To this end, the team has cut its FY2024 and FY2025 DPU forecasts by 2.6% and 7.0%.

"We had previously assumed that Keppel DC REIT would seek to novate the master leases of its Guangdong data centres to new leases with the underlying sub-lessees, which now seems unlikely in the foreseeable future," the team explains.

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"We now assume no income contribution from China in FY2024 and FY2025. We also factor in a weaker Australian dollar (AUD) against the Singapore dollar (SGD) in our forecasts, and raise our risk-free rate assumption from 2.75% to 3.0%," it adds.

As a result, OIR's fair value estimate is lowered to $1.74 from $1.81 previously.

That said, the team still sees the REIT as a "strong proxy" to the growing demand for data centre space, which is underpinned by increasing digitalisation and cloud adoption trends.

CGS International analysts Natalie Ong and Lock Mun Yee have kept their "hold" call on the REIT due to its lack of catalysts and the lack of clarity on the resolution of Bluesea.

The analysts see that Bluesea is likely to remain in arrears for the next 12 to 18 months. The tenant still owes the REIT RMB92.3 million or $17.3 million. 

However, the REIT's FY2024 DPU yield of 5.2% factors in most of the risks, they add.

During the 1QFY2024, Keppel DC REIT reported a stable q-o-q portfolio occupancy of 98.3%, but this is expected to decline to 98% in the 2QFY2024 when another one of its tenants, DXC Technology, returns 8,305 sq ft or 4.1% of the space it leases. The amount accounts for 7.6% of SGP1's net lettable area (NLA), Ong and Lock point out.

" We understand from management that Keppel DC REIT will need to reconfigure the space before leasing it out and we believe the returned space could be re-leased with positive reversions, given that the lease with DXC was signed three years ago," they note.

The REIT's 1QFY2024 DPU stood in line with their expectations at 25.4% of their FY2024 estimates.

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