Date: September 18, 2024
Broker: UOB Kay Hian
Company Overview
Digital Core REIT (DCREIT SP) is a pure-play data center real estate investment trust (REIT) with a portfolio of 10 freehold data centers. These are located in prime markets including North Virginia, Silicon Valley, Los Angeles, Toronto, Frankfurt, and Osaka. The total appraised value of its portfolio is US$1.3 billion, with its sponsor, Digital Realty, being the world’s largest data center owner and operator.
Stock Information
- Share Price: US$0.595
- Target Price: US$0.88
- Upside Potential: 47.9%
- Market Cap: US$772.8 million
- Bloomberg Ticker: DCREIT SP
Impending Acquisition of Frankfurt Data Center Stake
Digital Core REIT has exercised its option to acquire an additional stake of 0.2-40% in the Frankfurt data center from its sponsor, Digital Realty. This acquisition is expected to be highly accretive due to the favorable terms:
- Purchase Price: €47 million (US$51.7 million) for a 10% additional stake.
- Valuation Discount: 17.8% discount to the refreshed valuation, which increased by 13% to US$628.7 million as of June 2024.
- Net Property Income (NPI) Yield: 5.7% based on 1H24 figures.
If market conditions improve, Digital Core REIT may increase its acquisition to a 40% stake, which would result in 7% accretion to the 2023 distribution per unit (DPU).
Operational Improvements and Tenant Renewals
The Frankfurt data center, completed in 2017, has been performing well, with two anchor tenants—rated AAA and AA+—renewing their leases for five years with a positive cash rental reversion of 2% in 1Q24. This has helped boost the center’s occupancy to 98.5% in 2Q24. Additionally, it is powered entirely by renewable energy and remains a top asset in a supply-constrained market.
Financial Performance
Digital Core REIT has consistently delivered stable financial performance. The expected acquisition of additional interest in the Frankfurt data center is forecasted to contribute to improved DPU and NAV metrics:
- 2025F Distribution Yield: 6.1%
- NPI Contribution (Frankfurt): 5.7% yield expected on the newly acquired stake.
- Projected DPU Accretion: 1.7% for a 10% stake acquisition, with potential for 7% if market conditions allow for a larger stake purchase.
Key Financials (Forecasts for FY25):
- Revenue: US$91.5 million
- EBITDA: US$40.2 million
- Net Profit: US$36.3 million
- DPU: 3.6 US cents
- Net Margin: 39.7%
- ROE: 4.1%
Geographical Diversification and Expansion
With this acquisition, Digital Core REIT will continue to reduce its reliance on North America. The proportion of annualized rent from North America will drop from 66% to 63%, while Germany and Japan will contribute a combined 37% (Frankfurt: 29%, Osaka: 8%). This diversification provides the REIT with a more stable revenue base across key global data center markets.
Debt Management and Cost of Borrowing
Digital Core REIT has actively managed its debt, reducing its cost of borrowing by repaying US$140 million of floating rate loans at 6.4% in March 2024. Additionally, the REIT secured a four-year yen-denominated loan at a much lower cost of 1.5%. As of 2Q24, 93% of the REIT’s debt is hedged to fixed interest rates, stabilizing its cost of borrowing at 4.1%.
Lease Expiry Profile
The REIT has a well-managed lease expiry profile, with its largest asset in Northern Virginia (accounting for 11.4% of annualized rents) due for renewal in June 2025. Management is evaluating options, including potential lease renewal or redevelopment to support higher power-density AI workloads. The tight vacancy rate in Northern Virginia (0.9%) offers potential for rental rate increases.
Key Risks
- Lease Expiry Risk: The impending lease expiry at the Northern Virginia data center represents a risk if the tenant chooses not to renew or extend its lease.
- Occupancy Fluctuations: Although occupancy rates have remained strong, maintaining high occupancy rates, especially in newly acquired assets, will be critical to DCREIT’s continued financial performance.
Valuation and Recommendation
UOB Kay Hian maintains a BUY recommendation on Digital Core REIT, with a target price of US$0.88, based on a dividend discount model (cost of equity: 6.5%, terminal growth: 2.5%). The REIT’s attractive distribution yield of 6.1% for 2025, combined with its strategic acquisitions and operational improvements, positions it well for growth.
Environmental, Social, Governance (ESG) Initiatives
- Environmental: Digital Core REIT’s data centers are powered by renewable energy, with a strong focus on sustainability, particularly in the Frankfurt and Osaka centers.
- Social: The REIT ensures good governance practices with clear stakeholder engagement and has a long-standing commitment to ethical business practices.
- Governance: Managed by Digital Realty, the world’s largest data center owner, Digital Core REIT follows high standards of corporate governance, ensuring responsible management of its assets and operations.
