Date of Report: 18 October 2024
Broker: OCBC Investment Research
Investment Thesis
Keppel DC REIT (KDCREIT) is a prime investment in the expanding data center market, driven by the global rise in digitalization and cloud adoption. It has a diverse tenant base from high-growth sectors, including internet enterprises, IT services, telecommunications, and financial services. KDCREIT’s portfolio is characterized by one of the longest weighted average lease to expiry (WALE) profiles in the Singapore REIT sector, with 6.3 years by lettable area and 4.4 years by rental income (as of 30 September 2024). The REIT faces minimal refinancing risks due to limited debt maturities in FY25. However, uncertainties surrounding its Guangdong data centers, particularly concerning rental arrears, have impacted its distribution outlook, with recovery efforts progressing slowly. Management aims to mitigate this by seeking growth in other countries to reduce exposure to China.
3Q24 Financial Performance
- Distribution Per Unit (DPU): KDCREIT’s 3Q24 DPU increased by 0.4% year-on-year (YoY) and 6.1% quarter-on-quarter (QoQ) to 2.501 Singapore cents. The 9M24 DPU was 7.050 Singapore cents, a 6.5% decrease YoY, accounting for 77.1% of the initial FY24 forecast.
- Revenue & Net Property Income: Gross revenue rose by 8.9% YoY to SGD 76.9 million, while net property income (NPI) slightly decreased by 0.2% YoY to SGD 64.5 million. This was mainly due to allowances for losses related to its Guangdong data centers, impacting property operating expenses.
- Earnings Guidance: The report highlights positive earnings surprises due to the early completion of data center acquisitions in Japan, lower-than-expected finance costs, and additional income from Australian data center note subscriptions.
Positive Rental Reversions
KDCREIT achieved a significant positive rental reversion exceeding 40% for a major lease in Singapore during 3Q24, marking the second consecutive quarter of such high rental uplifts. Management remains optimistic about continued strong demand for colocation leases in Singapore, particularly with multiple leases expiring in 4Q24 and FY25. The REIT’s portfolio occupancy remained stable at 97.6%.
Expansion and Strategic Acquisitions
During 3Q24, KDCREIT completed the acquisition of a data center in Tokyo, Japan, increasing its aggregate leverage ratio by 3.9 percentage points QoQ to 39.7%. Following this acquisition, KDCREIT’s average cost of debt was 3.3%, with 71% of its debt hedged. Management’s strategy includes pursuing accretive acquisitions to enhance its portfolio, with a focus on assets in Singapore that may yield an initial net property income (NPI) of 6%-7%.
Concerns Over China Operations
Issues persist regarding KDCREIT’s Guangdong data centers, particularly related to rental arrears due to a credit profile concern with a master lessee. The shortage of graphic processing unit (GPU) chips has been a significant obstacle, affecting the center’s performance. Despite slow recovery, the management is optimistic that the Chinese government’s recent stimulus efforts may help improve the economic situation and boost demand, particularly from AI-related applications.
ESG Initiatives
KDCREIT continues to enhance its ESG credentials. It was upgraded in late November 2022 due to lower accounting risk compared to global peers. The REIT adheres to a ‘one share one vote’ principle, aligning economic exposure with voting power. It has committed to significant climate action, being a signatory of the Climate Neutral Data Centre Pact, and aims to cut its Scope 1 and Scope 2 emissions by 50% by 2030. Furthermore, KDCREIT plans to introduce renewable energy in at least 50% of its colocation assets by the same year.
Potential Catalysts for Growth
- Portfolio Expansion: Opportunities for stronger-than-expected portfolio valuation improvements.
- Accretive Acquisitions: Potential for acquisitions that could enhance DPU growth.
- Increased Occupancy: Enhanced occupancy levels at data centers in Singapore, Dublin, and Malaysia.
Risks and Challenges
- Data Outsourcing Trends: Any slowdown in the global trend towards data outsourcing could adversely impact demand for data centers.
- Regulatory Changes: Changes in the regulatory environment in the countries where KDCREIT operates could affect its performance.
- Acquisition Risks: Overpaying for new assets may lead to lower returns, particularly if there is a compression in cap rates.
Financial Summary (FY23 – FY25 Estimates)
- Gross Revenue: Estimated to grow from SGD 281.2 million in FY23 to SGD 293.4 million in FY25.
- Net Property Income: Projected at SGD 265.7 million for FY25.
- Distribution to Unitholders: Expected to reach SGD 164.4 million by FY25, reflecting a stable growth in DPU.
Valuation and Outlook
KDCREIT’s share price was SGD 2.22 as of the report date, with a fair value estimate of SGD 2.15. It is currently trading at a relatively low FY24 and FY25 distribution yield of 4.2% and 4.3%, respectively. The report indicates potential upside from future acquisitions, especially in Singapore, where management could leverage its existing partnerships.
