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DBS maintains 'buy' on Digital Core REIT on further DPU accretion

Bryan Wu
Bryan Wu11/23/2022 11:26 AM GMT+08  • 4 min read
DBS maintains 'buy' on Digital Core REIT on further DPU accretion
The analysts say Digital Core REIT received overwhelming support for the proposed acquisition of a 25% stake in the Frankfurt data centre (DC).
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DBS Group Research analysts Dale Lai and Derek Tan have maintained their “buy” call for Digital Core REIT with the REIT’s upsized debt-funded acquisition or share buyback set to generate further distribution per unit (DPU) accretion.

The analysts have also kept their target price (TP) unchanged at 90 US cents ($1.24). The target price was previously reduced from US$1.15 in the analysts’ Oct 27 report.

“We previously revised our projections for Digital Core REIT to account for higher borrowing costs, as the REIT has hedged 50% of its outstanding loans,” Lai and Tan write in their Nov 21 report.

The analysts’ current target price is based on a discounted cash flow (DCF) valuation with a weighted average cost of capital (WACC) of 6.2%, or a risk-free rate of 3.5%, implying a normalised target yield of 4.2% in the next two years. Baked into this valuation are the assumptions of US$140 million of debt-funded acquisitions by the end of FY2022 and all-in financing costs averaging 3.0% in FY2022 and 4.0% in FY2023.

At its extraordinary general meeting (EGM) held on Nov 18, Lai and Tan say the REIT received overwhelming support for the proposed acquisition of a 25% stake in the Frankfurt data centre (DC). “The resolutions to issue new units have also been approved and we understand that management has committed to only carrying out an exchange for risk (EFR) if it can be done close to net asset value (NAV),” they say.

At its current trading price of 58.5 US cents, which is around a 31% discount to NAV, the analysts note that it is unlikely that Digital Core REIT will be able to carry out an EFR in the near term.

See also: UOB Kay Hian upgrades Frencken to 'buy' due to 'positive outlook' for its key customer and improving cost pressures

“However, Digital Core REIT will still have ample debt headroom to upsize its acquisition of the Frankfurt DC. Based on the proposed debt-funded acquisition of a 25% stake in the Frankfurt DC, Digital Core REIT’s gearing will go up to around 33.5%,” say Lai and Tan.

They write that if Digital Core REIT were to double its acquisition stake of the Frankfurt DC and upsize its take to 50%, its gearing would only go up to around 39.5%, still within the REIT’s long-term gearing target of less than 40%, which could potentially double the DPU accretion from around 2.0% to 4.0%.

“We are reminded that Digital Core REIT currently has the mandate to carry out a share buyback to repurchase up to 10% of the units in issue. Based on this, we look at the possible scenarios of share buybacks, and the potential DPU and NAV accretion,” say the analysts.

See also: Citi maintains 'buy' rating on Genting Singapore off the back of MBS results beat

“From the following scenario analysis, Digital Core REIT has the debt headroom to carry out the share buyback up to a maximum of 10% of its outstanding units, and gearing will still only go up to around 39%,” they add. “Based on the various amounts of share buybacks, DPU accretion could range anywhere from 0.4% to 2.0%, and NAV accretion could be anywhere between 0.6% to 3.4%.”

Meanwhile, the REIT’s earnings are underpinned by strong fundamentals. According to the analysts, its portfolio of fully occupied data centres and a long weighted average lease expiry (WALE) of around 5 years ensures income stability and visibility. In addition to the booming data centre industry, annual rental escalations of around 2% for its portfolio provide for organic growth in its earnings, they add.

They note that the REIT’s pipeline could make it one of the largest S-REITs, with a strong commitment from its sponsor to grant the REIT a right of first refusal (ROFR) for around US$15 billion worth of data centres globally. “In addition, 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 currently in the negative territory, Digital Core REIT could look at pipelines in Europe and Japan,” say Lai and Tan.

Key upsides to their view include a slower-than-anticipated rise in interest rates and a larger-than-expected acquisition.

As at 10.53am, units in Digital Core REIT are trading 0.5 US cents or 0.91% up at 55.5 US cents with a dividend yield of 4.4%.

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