DBS Group Research’s Dale Lai and Derek Tan have slashed their target price for Digital Core REIT (DCREIT) from US$1.30 ($1.80) to US$1.15, although they still maintain their “buy” call on the stock
The analysts say that the lowered target price was due to them revising projections for DCREIT to account for higher borrowing costs, as the REIT has hedged 50% of its outstanding loans.
The assumptions baked into their valuations are US$250 million of debt-funded acquisitions in FY2022, and all-in financing costs averaging at 2.8% in FY2022 and 3% in FY2023.
However, a bright spot for DCREIT, they say, is that its earnings are “underpinned by solid fundamentals.”
Lai and Tan note that DCR has a portfolio of fully occupied data centres and a long weighted average lease expiry (WALE) of about 5.5 years, which ensures income stability and visibility.
“In addition to the booming data centre industry, annual rental escalations of c.2% for its portfolio provide for organic growth in earnings.”
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The analysts also highlight that DCR has been granted a right of first refusal (ROFR) for US$ 15 billion worth of data centres globally.
Furthermore, DCREIT’s sponsor, Digital Realty also has data centre developments worth a further US$5 billion that could be made available to DCREIT when completed.
They are of the view that although cap rate spreads in the US are in the negative territory currently, DCREIT could still look at pipelines in Europe and Japan.
The cap rate spread is the difference between interest rates and the cap rate for the property, which is the ratio of annual income produced by that property to its purchase price.
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Lai and Tan say that the US$1.15 target price is based on a discounted cash flow valuation with a weighted average cost of capital (WACC) of 5.4% and risk-free rate of 3%, which implies a normalised target yield of 3.5% in the next two years.
Some risks to their view, they warn, are slower-than-anticipated acquisition growth and a further spike in borrowing costs.
As of 12.23pm, units of DCREIT are trading at a 77 US cents, with a FY2022 price to NAV ratio of 0.9 and dividend yield of 5.2%
