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DBS lowers Digital Core REIT’s TP to 75 US cents despite the lift in overhang

Felicia Tan
Felicia Tan • 3 min read
DBS lowers Digital Core REIT’s TP to 75 US cents despite the lift in overhang
A Digital Core REIT asset in the US. Photo: DCREIT
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DBS Group Research analysts Dale Lai and Derek Tan has kept “buy” on Digital Core REIT (DCREIT) after the REIT’s distribution per unit (DPU) of 3.70 US cents (5 cents) for the FY2023 ended Dec 31, 2023, stood in line with their expectations.

“Both tenant bankruptcies and soaring interest rates faced by DCREIT in FY2023 were reflected in the 7.0% y-o-y decline in DPU to 3.70 US cents,” they write in their report dated Feb 2.

In their report, Lai and Tan highlight the REIT’s solution to the bankruptcy of its tenant, noting that the “overhang” on the stock has been lifted. With stable gearing at a “healthy” 33.5% as well, the REIT can now shift its focus to future growth initiatives, the analysts add.

“The agreed package deal with Brookfield involves six transactions and is expected to be yield-neutral,” they write. “However, our estimates suggest a slight dilution to DPU of approximately 3%, primarily due to timing differences and vacancy risks. This is perceived as a trade-off between reducing concentration risk and accepting a marginal dilution in DPUs. The overall sentiment is positive, as the package deal removes the overhang from the customer bankruptcy.”

“Importantly, it allows DCREIT to diversify its tenant and asset base while marking its entry into the Japanese market and gaining exposure to the rapidly growing data centre market in Asia,” they note.

Other pluses include DCREIT’s recent acquisitions in Frankfurt and Osaka, which are expected to drive earnings. Furthermore, the REIT’s pipeline of assets from its sponsor, valued at over US$15 billion, allows the REIT to potentially grow into the largest pure-play data centre Singapore REIT (S-REIT), note Lai and Tan.

See also: Singtel's higher dividends keep analysts positive, target prices increase

Another upside for the REIT is the robust demand for data centres in key markets with the lack of available capacity.

“DCREIT’s presence in some of these key markets throughout the US, Canada, and Europe means it continues to benefit from such robust demand. Moreover, the long weighted average lease expiry (WALE) for its assets ensures income stability in the foreseeable future. In the event of any vacancy, DCREIT should be able to quickly backfill the space, given the healthy demand dynamics in those markets,” they write.

In spite of the optimistic outlook, the analysts have lowered their target price to 75 US cents from 90 US cents. This is based on a discounted cash flow (DCF) valuation with a weighted average cost of capital (WACC) of 6.2% and a risk-free rate of 3.5%. The new target price implies a normalised target yield of 5% in the next three years.

Units in DCREIT closed flat at 66.5 US cents on Feb 7.

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