Now would be a good time to buy into Digital Core REIT, say DBS Group Research analysts Dale Lai and Derek Tan. The analysts believe that the REIT is now at an “attractive” re-entry point with its share price of 54 US cents (74 cents) as at Feb 3, representing around 0.9 times the REIT’s P/B and implying an FY2025-FY2026 yield of 6%.
To be sure, its estimated FY2025-FY2026 yield is higher than its Singapore Exchange (SGX)-listed peers, which are largely trading at premiums of 1.2 times – 1.4 times their P/B.
From an EV/ebitda basis, Digital Core REIT is also trading at a lower multiple of 23 times compared to its broader global peers’ multiples of 25 times to 29 times.
“We believe that the discount is largely due to investors’ uncertainty surrounding the distribution growth outlook for the REIT, especially from the recent major non-renewal at [the] Linton Hall data centre,” Lai and Tan write in their Jan 28 report.
While noting that an extended vacancy of the property will have a “significant” impact to the REIT’s earnings and distributions, the analysts see that the market attention over the non-renewal could be an “over-reaction”.
Despite the potential downside of 19% to its distribution per unit (DPU), Lai and Tan believe Digital Core REIT is “well-positioned” to address the vacancy, as it can tap on the record-low market vacancy rates in Virginia to backfill the space quickly.
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In addition, the REIT has the potential to achieve higher rental rates, given that market rents are now 20% to 30% higher than the expiring lease.
The analysts also believe that investors have largely ignored Digital Core REIT’s initiatives on financial management, leasing its existing assets, as well as acquisitions, all of which were completed in recent months. The REIT recently completed the acquisition of an additional 40% stake in its Frankfurt data centre and 10% stake in its Osaka data centre, both of which will drive earnings.
These moves, say Lai and Tan, could contribute “positively” and limit the vacancy’s fall-off in distributions to just 4.0% less in FY2025.
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The analysts’ estimates are based on the data centre being vacant for six months and better if Linton Hall is re-let ahead of time. Assuming that the space is tenanted by the end of FY2025, the analysts believe DPUs could jump by 11% y-o-y in FY2026, bringing it to a four-year high.
At present, the analysts’ estimates have not included the potential annexe block to be developed. But once the annexe is built, it could add 20MW to 30MW of IT load capacity. It could then offer a potential estimated yield on cost of 10-12% with DPU accretion of between 13%-19% in two to three years, they write.
In it for the long run
Lai and Tan have kept their “buy” call on Digital Core REIT as they see the REIT “playing the long game” with “more stability than [the] market is fearing”.
The REIT, which only has data centres in its portfolio, has structural tailwinds ahead of it with robust demand for data centres in key markets such as the US, Canada, Europe and Japan.
Moreover, the REIT enjoys income stability thanks to a long weighted average lease expiry (WALE) and should be able to quickly backfill spaces given the healthy demand dynamics in the markets it is present in.
Other positives include the REIT’s pipeline assets from its sponsor, which is valued at over US$15 billion. Digital Core REIT has been granted a right of first refusal (ROFR) of these assets, which could allow the REIT to grow into the largest pure-play data centre S-REIT, Lai and Tan note.
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Furthermore, the REIT has a “healthy” debt headroom, which will give it enough flexibility to conduct further accretive acquisitions.
“We believe that once markets become more conducive for further acquisitions, Digital Core REIT will be able to grow further,” the analysts write.
That said, the analysts have lowered their target price to 72 US cents from 75 US cents to account for the non-renewal. The new target price implies a normalised target yield of 5% in the next three years.
Units in Digital Core REIT closed 1.5 US cents lower or 2.7% down at 54 US cents on Feb 3.
