Data centres are highly sought after as investments due to their high occupancy rates and ever increasing demand from companies all over the world to store and manage data.
Consequently, data centre REITs have reported resilient results thus far.
REITs that own data centres have a track record of providing strong returns to investors.
An example is Keppel DC REIT (SGX: AJBU).
However, things have taken a turn for the worse this year for REITs as a flurry of worries descends on the sector.
Against this backdrop of uncertainty and fear, investors should always keep a level head and focus on the stock’s fundamentals.
Keppel DC REIT recently released its earnings report for the quarter ended 30 September 2022 (3Q2022).
Here are five highlights from the REIT’s business update that investors should take note of.
1. A modest financial performance
For the quarter, the REIT reported a modest set of financial results.
Gross revenue grew by 1.4% year on year from S$69.3 million to S$70.3 million in 3Q2022.
This was only a mild improvement from the 0.7% year on year increase in gross revenue from S$204.5 million in the nine months ended 2021 (9M2021) to S$205.9 million in 9M2022.
Net property income (NPI) rose by 0.5% year on year to reach S$64.1 million.
Revenue growth was mainly driven by contributions from acquisitions and investment, as well as completed asset enhancement initiatives (AEI).
On the back of these results, the REIT declared a distribution per unit (DPU) of S$0.02585 for 3Q2022, 5% higher than the same period last year.
The increase in DPU was mainly driven by higher finance income, which includes the coupons received from M1’s bonds and preference shares.
2. Portfolio updates
In December 2021, Keppel DC REIT completed its acquisition of Guangdong Data Centre 1 in China, its first investment property in China.
To further strengthen its portfolio, the REIT has subsequently entered into agreements with Bluesea to acquire another two Grade A data centre facilities in Guangdong, for approximately S$297.1 million.
The acquisition of these two data centres is expected to be completed by the end of this year and by 3Q2023 respectively.
Following the completion of these latest transactions, investment properties in China will constitute 8.3% of the REIT’s total portfolio.
This brings the Keppel DC REIT’s total portfolio to 23 data centres, worth a total of S$3.6 billion, across nine countries.
In addition, it has S$2 billion worth of data centre assets under development and management, through its sponsor, Keppel T&T, as well as Keppel Corporation Limited’s (SGX: BN4) private data centre funds.
Having a strong sponsor allows the REIT to access a ready pipeline of properties that it can tap on for future acquisitions.
3. Secular growth trend
As a pure-play data centre REIT, the REIT’s future growth is dependent on the continued demand for quality data centres.
As the world continues to digitalise, we are starting to see a massive amount of investments being deployed to build essential digital infrastructure.
Recent years have seen the rapid adoption of Internet of Things (IoT), automation, cloud computing, artificial intelligence and the ongoing rollout of 5G infrastructure.
Moving forward, the amount of data being produced and processed is expected to increase exponentially.
The world’s data needs continue to grow exponentially, while the growth in key data centre hubs continues to be limited by power and land availability
Coupled with the push for data privacy and national sovereignty by governments, this only creates more demand for data centres.
In fact, Asia Pacific is set to become the world’s largest data centre region over the next decade.
Moreover, data centre demand in Europe in the first half of the year (1H2022) has surpassed the total demand in 2021, underpinned by hyperscale demand.
Hence, investors who strongly believe that the future will be a data-driven one should consider an investment in this pure-play data centre REIT as a proxy for the growth in the data centre sector.
4. Consistent operating metrics
Keppel DC REIT achieved a portfolio occupancy of 98.6%, up slightly from 98.2% in 1H2022.
Its portfolio weighted average lease expiry (WALE) stood at a healthy 8.7 years as of 30 September 2022.
In comparison, its WALE was 7.6 years in 1H2022.
The REIT also has a well-spread debt maturity profile, with the bulk of debt expiring in 2027 and beyond.
The REIT also reported continued leasing momentum with healthy renewals and expansion by existing clients.
However, unitholders have to be aware of the concentration risks that the REIT carries.
Its largest customer, which is supposedly one of the largest technology companies globally, contributes 36.0% of its total rental income.
On the bright side, this concentration risk should gradually be alleviated as the REIT continues to expand its portfolio.
5. Buffering against higher interest rates and rising inflation
To curb rising inflation, the US Federal Reserve has hiked interest rates by 0.75 percentage points over four consecutive sessions.
Higher interest rates directly translate into higher finance costs, which will in turn reduce DPU.
As a result, many investors have shunned away from investing in REITs, preferring to put their money into seemingly safer and more attractive assets, such as bonds and fixed deposits.
Such sentiment has manifested itself in the form of lower REIT prices this year..
Management has announced that a 1% increase in interest rates would lead to 3Q2022’s DPU declining by 2.1%.
Keppel DC REIT’s trailing 12-month (TTM) DPU ended 30 September 2022 amounted to a total of S$0.10099.
The 3% increase in interest rates (i.e. 0.75% x 4) will result in TTM DPU declining by 6.3%.
While the impact of higher interest rates cannot be avoided, a strong balance sheet helps to provide some buffer against their effects.
For instance, 74% of Keppel DC REIT’s borrowings were based on fixed interest rates as of the recent quarter, slightly lower than 76% in the previous quarter.
Meanwhile, the REIT’s aggregate leverage ratio increased by 2.2 percentage points from the previous quarter to 37.5%.
This increase was mainly due to the financing of acquisition of Guangdong Data Centres 2 and 3.
The average cost of debt increased from 1.9% in 2Q2022 to 2.3% for the year to date.
Interest coverage ratio (ICR) decreased from 9.2 times to 8.5 times quarter-on-quarter.
Having said that, an ICR of 8.5 times is still considered very healthy.
This high ICR indicates that the REIT’s net property income can service 8.5 years of finance costs
This is a relief for investors as it means the REIT has little difficulty fulfilling its debt obligations, even in this high interest rate environment.
Since almost half of the REIT’s investment portfolio is outside Singapore, this means that a significant portion of its gross revenue comes from countries outside Singapore.
To reduce foreign currency risks, the REIT has adopted natural hedging by borrowing in currencies that match its corresponding investments.
Only 33.1% of the REIT’s total debt is denominated in Singapore Dollars (SGD), while 37.5% is denominated in Euros (EUR).
The REIT has also faced minimal impact from rising electricity costs, as it has passed through more than 90% of electricity costs to its colocation clients.
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Disclosure: Ryan Yap does not own any of the shares mentioned.
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