The Positives
The Negatives
Note: KDC will be adopting half-yearly reporting. The next announcement of financial statements will be for the half-year period ending 30 June 2020.
Outlook
Higher data traffic and the accelerated pace of cloud and technological adoption is expected as more work from home. This will cause tenants to deplete their space capacity at a faster rate than planned, which may lead to tenants needing to replenish rack space post-COVID.
Tax transparency for KDC SG 4 (acquired 31 Oct 19) is expected to be granted within 6 to 9 months after application, based on previous tax transparency applications (KDC SG 5’s approval took c.6months). Minor delays possible in light of the COVID-19 disruptions.
Gearing will increase from 30.7% to 32.8% for FY20 due to acquisition of Kelsterbach DC (Germany, TBC 1H20) and the balance of the 999-year land lease for KDC Dub 1. With KDC‘s strong balance sheet and high interest coverage ratio of 12.8x, we view this utilisation of gearing headroom favourably.
Strong price appreciation has compressed yields to the 3%-4% range, on the low side for SREITs. We like the data centre asset class due to its future-ready characteristics, growing pace of cloud and technological adoption and limited supply. Since listing, KDC has grown AUM by c.2.5x and DPU by 11.3%. We believe that their operating track record, strong portfolio metrics and index inclusion has driven yield compression. KDC’s P/NAV for 2019 was 2.14x, a significant premium above other industrial SREITs. However, the stability and resilience in earnings, as well as income visibility from long WALE of 8.3 years, as well as comparison to its peers leads us to think that the premium is justified. KDC’s low FY20e and FY21e yield of c.3.7% and 3.9% respectively are similar to the yields of US-listed data centre REITs of 1.5%-4.1%, as shown in Figure 1.
Downgrade to HOLD with a higher target price of $2.20 (previously $2.06)
We adjust our estimates to reflect the acquisition of Kelsterbach DC and the conversion of two floors of Shell&Core space at DC1 to a Fully-Fitted lease. We lowered our cost of equity by 100bps to reflect the lower interest rates and lower our beta slightly as we believe the data centre asset class should be less sensitive to market factors.
We continue to like KDC for reasons mentioned above. However, we think that upside is limited given the strong ride up in prices, with yields at c.3%, not compelling. We recommend accumulating on pull back.
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