• 1Q23 DPU rose 3% YoY to 2.541 Singapore cents, due to the acquisitions of Guangdong Data Centre 2 and 3; completed asset enhancement initiatives (AEI); renewals and income escalations; and tax savings from the approval of the NetCo Bonds being qualified as Qualifying Project Debt Securities (QPDS).
• These were partially offset by lower contributions from some of its Singapore co-location assets arising from higher facilities expenses including electricity costs, higher finance costs and the depreciation of EUR, AUD and GBP against SGD.
• Downgrade from BUY to ACCUMULATE. Target price lowered from S$2.58 to S$2.26 on higher interest expense and cost of equity. Catalysts include more accretive acquisitions and lower-than-expected interest costs. The current share price implies FY23e/24e DPU yields of 4.7%/4.9%.

The Positives

+ Portfolio occupancy remained stable at 98.5% QoQ, with a portfolio WALE of 8.2 years. 14.3% of leases by rental income will expire in 2023. In our view, the likelihood of lease renewal is high due to the high costs of tenant re-location and 54% of its assets are located in Singapore.  

+ Prudent capital management, with 73% of debt on fixed rate. Average cost of debt increased from 2.7% in 4Q22 to 2.8% in 1Q23. A 100bps increase in interest rates would lower DPU by c.2.2%. Gearing also edged up from 36.4% at end 2022 to 36.8%. KDCREIT has no refinancing obligations in 2023 after refinancing all loans expiring in 2023 (4.9% of total) in early April at 3-month EURIBOR plus an agreed spread. Foreign sourced income is also substantially hedged till the end of 2023, and partially thereafter until the middle of 2024. EU accounts for c.24% of income.

Outlook

Keppel DC REIT is on the lookout for acquisitions, including off-market transactions. Japan is a potential target market, where acquisition cap rates are around 5% and interest rates remain low. The sponsor also has >S$2bn worth of data centre assets under development and management that KDCREIT could potentially acquire.

There is a final payment of c.S$142mn upon the completion of Guangdong Data Centre 3, expected to take place in 3Q23. Our forecasts assume this would be funded via a cash call.

Downgrade from BUY to ACCUMULATE with a lower DDM TP of S$2.26 (prev. S$2.58)

KDCREIT’s NPI yield of 7.2% and long WALE of 8.2 years is still superior to other asset classes. Its largest tenants are some of the biggest internet enterprises in the world, with its largest contributing 35.5% of rental income. Catalysts include more accretive acquisitions and lower-than-expected interest costs. The current share price implies FY23e/24e DPU yields of 4.7%/4.9%.

• 1Q22 DPU of 2.466 Scts (+0.2% YoY) was in line, forming 24.9% of our FY22e forecast.
• Contributions from investments in Eindhoven DC, Guangdong DC, London DC and NetCo bonds totalling c.S$386mn, and completion of AEI at DC1 and Intellicentre3 development were wiped out by higher electricity costs, provision for litigation and absence of rental support for KDC4.
• Maintain BUY on earnings stability and attractive entry price for future-ready DC assets. FY22-26e DPUs lowered by 3.7-6.1% due to provision for litigation and higher electricity costs, resulting in 8.2% reduction in our DDM-TP (COE 5.88%) from S$2.81 to S$2.58. The current share price implies FY22e/23e DPU yields of 4.7%/4.8%.

The Positive

+ Portfolio occupancy up 0.4ppts YoY, from 98.3% to 98.7%. This was due to higher occupancy at DUB1, which improved from 82.3% to 95.9%. KDC also renewed its lease at Basis Bay, extending the the weighted average lease expiry (WALE) at the property from 0.2 years to 4.7 years. While committed occupancy was not disclosed, we understand from the management that the tenant has downsized its space. Occupancy at Basis Bay is expected to decline from 63.1% when the new lease kicks in. Portfolio WALE lengthened from 7.5 years to 7.7 years.

The Negatives

-  Litigation against DXC over revenue for provision of colocation services. KDC announced its litigation against DXC on 21 March 2022. The suit, which was initiated by KDC, was for c.S$14.8mn in colocation service revenue in connection with provision of facility management services at KDC1 for the 4-year period between 1 April 2021 and 31 March 2025. The affected occupancy is c.0.4% of KDC’s NLA as at 31 December 2021, and the impact arising from the disputed sum per annum is approximately 2.0% of FY21’s distributable income.

- Slight increase in cost of borrowing and gearing. Cost of borrowing remains low despite increasing from 1.6% to 1.8%. Portion of debt on fixed rates crept up from 74% to 76% while gearing inched up slightly from 34.6% to 36.1% post-acquisition of London DC but remains below the 50% regulatory limit.

Outlook

About 17.1% of leases are due to expire in FY22, likely from KDC4 given the short WALE of 0.4 years. While the data centre moratrium in Singapore has been lifted, construction of new supply is expected to take 2-3 years to come online. Tenant stickiness is high due to the significant cost of relocation. We remain optimistic about KDC’s tenant retention ability over the mid-term.

Including the acquisition of London DC, KDC’s AUM grew 16.7% since Dec 20. Data centre cap rates were stable QoQ. KDC continues to source for acquisitions in Asia, Europe and US, with a preference for off-market deals which could provide better entry yields. KDC also has a ROFR on the remaining five data centres located within the Bluesea Intelligence Valley from the vendor of Guangdong DC.

Maintain BUY with a lower DDM TP of S$2.58 (prev. S$2.81)

FY22-26e DPUs lowered by 3.7-6.1% due to provision for litigation and higher electricity costs, resulting in 8.2% reduction in our DDM-TP from S$2.81 to S$2.58. The current share price implies FY22e/23e DPU yields of 4.7%/4.8%.

• FY21 DPU of 9.851 Scts (+7.4% YoY) was in line, forming 100.3% of our forecast. FY21 revenue increased due to acquisitions, completion of redevelopment at Intellicentre 3 and various AEIs in Ireland and Singapore.
• S$386mn in investments made in FY21 could provide more than 4% in DPU accretion for KDC.
• Maintain BUY on earnings stability and attractive entry price for future-ready DC assets. FY22e-25e have been lowered by 0.9-4.1% on the anticipated rising cost of borrowing. Our DDM-based TP dips from S$3.03 to S$2.81 on lower DPU estimates and assumption of higher cost of equity of 5.88% (previous 5.75%). The current share price implies FY22e/23e DPU yields of 4.8%/4.9%.

The Positives

+ Portfolio occupancy up 0.5ppts YoY, from 97.8% to 98.3%. This was due to the acquisition of fully-leased Guangdong DC and occupancy improvements at KDC1 and Dub1. Occupancy at KDC1 inched up 2.0ppts to 93.1%, while occupancy at Dub1 saw a 1.1ppt improvement,  at 82.3%.

+ Portfolio valuation up 8.9%, or S$213mn, on a same-store basis, largely driven by cap rate compressions. Singapore properties accounted for 83% of the valuation uplift, with cap rate range compressing approximately 55-82bps YoY, from 4.95%-10.12% to 5.25%-9.31%. Intellicentre Campus in Australia accounted for 17% of the valuation uplift after the TOP of Intellicentre 3 in Jul 21, while Cardiff DC in the UK took a 7% haircut owing to more conservative assumption following a change of valuer.

+ S$386mn in investments to secure FY22 DPU growth. KDC announced S$386mn in investments in FY21 which carry an average EBITDA yield of 7.1% (Figure 1). Given the timing of legal completion, these investments will contribute more meaningfully towards FY22 earnings.

The Negative

-  KDC4 and Basis Bay DC leases ticking down to expiry. 18.7% of leases by GRI are up for renewal in FY22, likely from KDC4 and Basis Bay DC given the shorter WALEs of 0.7 years and 0.5 years at these assets. The manager is still in the midst of renewal discussions but remains open to divesting if offer prices are compelling.   

• 3Q21/9M21 DPU of 2.462/7.386 cents grew 4.5%/9.7% YoY. 9M21 DPU was in line, at 75% of our FY21e estimate.
• S$281mn in completed and proposed investments YTD could provide more than 6% in DPU accretion for KDC.
• Maintain BUY on the resilient data centre demand. FY21e/22e DPU dips 0.3%/4.1% after we adjust our forecasts to factor in recent transactions. DDM-based TP (COE 5.75%) cut by 5.3% from S$3.20 to S$3.03 due to lower FY21e-FY25e DPU estimates. Figure 1 summarises the estimated contributions from announced investments versus our previously assumed S$500mn acquisition.

The Positives

+ 3Q21 DPU +4.5% YoY due to acquisitions and AEI. DPU lifted by acquisition of Amsterdamn DC and Eindhoven Campus in Dec20 and Sep21, and AEIs at KDC SG5, Dub1, Dub2 and DC1. KDC renewed c.7.2% of expiring GRI in 3Q21, bring FY21 expiries to 0.4% of GRI. Occupancy remains high at 98.1% with WALE increasing QoQ from 6.5 years to 7.0 years due to the commencement of a 20-year lease at Intellicentre Campus in Jul21.

+ Fruitful quarter of capital recycling. KDC divested iSeek DC for S$35.3mn in Aug21, 21% and 1.4% above IPO and market valuation respectively. It also acquired Eindhoven Campus in Sep21 and inked the NetCo agreement in Oct21. The three investments (Figure 1) announced year-to-October totalled S$281mn, carrying weighted average yield of 8.3%. The acquisition of Eindhoven Campus was completed on Sep21, while the remaining two investments – Guangdong DC and investment in NetCo bonds – are estimated to be completed in 4Q21. We estimate that these acquisitions could provide more than 6% DPU accretion for KDC.

The Negative

- Basis Bay DC lease expiring in c.8 months may be at risk. Basis bay is a colocation asset located in Malaysia. Occupancy has remained at 63.1% since 2Q17. The management has previously cited weak interest in the asset. However, NPI contribution from this asset has been reduced by AUM growth and currently contributes c.1% to NPI.

Outlook

KDC is evaluating several on- and off-market deals with cap rates ranging 4-5%. Cap rates have compressed 50-75bps since a year ago. KDC’s low cost of debt of 1.6% should still leave room for accretive acquisitions. The Sponsor group of affiliates manages more than S$2bn in data centre assets KDC could potentially acquire. KDC also has a ROFR on the remaining five data centres located within the Bluesea Intelligence Valley from the vendor of Guangdong DC.

Still no updates on Singapore’s moratorium on data centres which was rumoured to be lifted this year. Should it happen, supply could increase over the next 2-4 years. However, stickiness of data-centre tenants and Keppel’s track record as a data-centre operator should help it retain tenants.

Maintain BUY with a lower DDM TP of S$3.03 (prev. S$3.20)

FY21e/22e DPU dips 0.3%/4.1% after we adjust our forecasts to factor in the divestment of iSeek DC and investments in Eindhoven Campus, Guangdong DC and NetCo, while reversing our previously assumed S$500mn acquisition at 6% NPI yields. DDM-TP cut by 5.3% from S$3.20 to S$3.03 due to lower FY21e-FY25e DPU estimates. Figure 1 summarises the estimated contributions from announced investments versus our previously assumed S$500mn acquisition. Current share price implies FY21e/22e DPU yields of 4.1% and 4.5%.

Stock catalysts are expected from acquisitions and higher 5G, smartphone and cloud adoption. Despite its expansion of mandate, KDC will remain data centre-focused, maintain at least 90% of its assets in data centres and will only consider assets that have been 50% leased at a minimum.

• 2FY20 DPU of 9.17 Scts (+20.5% YoY) was in line, forming 97.1% of our estimate.
• Earnings improved on the back of acquisitions and higher portfolio occupancy.
• Upgrade to ACCUMULATE from NEUTRAL with DDM-based TP raised from S$2.91 to S$3.20 (COE 5.75%) after we raise occupancy. We assume S$500mn of acquisitions in our forecasts.

+ Positives

+ FY20 NPI and DPU grew 37.7% and 20.5% YoY respectively, led by newly-acquired KDC4 and DC1 in Singapore (in 2H19) and Kelsterbach DC in Germany (on 1 May 2020). Portfolio occupancy was also higher from completed AEI and higher demand.

+ Portfolio occupancy improved QoQ from 96.7% to 97.8% (FY19: 94.9%). Higher occupancy in 4Q20 stemmed from: 1) the handover of newly converted DC space at KDC5 which lifted occupancy from 84.2% to 100%; 2) tenant expansion at KDC1 which increased occupancy from 89.2% to 91.1%; and 3) a new tenant at KDC2 which raised occupancy from 93.5% to 98.2%. AEI to bring more power onsite at Dub1 also allowed KDC to lease out additional space, bumping up its occupancy from 61.8% to 81.1%.

+ Acquired Amsterdam DC on 24 Dec 2020 for S$48.1mn; initial NPI yield of 5.1%. Amsterdam DC comprises a shell & core data centre and an office component, with occupancy of 99.1%. The asset is located near the Amsterdam Internet Exchange, one of the world’s largest hubs in terms of connections and traffic. Amsterdam DC has an occupancy of 99.1% and is leased to data-centre and IT service firms.

- Negative

- Natural decay of leases reduced WALE to 6.8 years (FY19: 8.6 years). Colocation (Colo) leases are the most profitable leases as rents include charges for facility management and the rental of M&E equipment. However, Colo leases typically run on shorter WALEs of 2.7 years vs. 11.2 years for fully-fitted and 7.3 years for shell & core data centres. Fortuitously, most of KDC’s Colo leases are in Singapore, which is a rising rental market due to limited new supply. As such, shorter WALEs should allow KDC to capture higher rents as the leases are marked to market upon renewal. In contrast, with a WALE of 1.5% and persistently low occupancy of 63.1%, KDC’s struggling Malaysian asset, Basis Bay (0.8% of AUM), may face occupancy risks should its existing tenant decide not to renew.

Outlook

Evaluating potential acquisitions. KDC is evaluating several piecemeal and portfolio acquisitions with cap rates of 5-7%. However, travel restrictions in several countries have prevented KDC from physically inspecting the assets overseas. Management has found a way around this, which is to focus on shell & core assets which are more passive in nature and rely on third-party valuers. Using this strategy, KDC was able to acquire Amsterdam DC before the year ended.

Demand-supply gap to push up market rents. Singapore is KDC’s core market, accounting for 56% of its AUM. Given the moratorium on data centres in Singapore, we expect market rents to be bid up in the coming two years. Present higher demand has led to higher occupancy for KDC’s portfolio, though market rents have not moved. While KDC’s portfolio occupancy in Singapore is high at 97.0%, Colo leases in Singapore have WALEs of 1.4-4.0 years. These coincide with expected rent appreciation. In the meantime, KDC is expected to benefit from organic growth as many of its leases have built-in periodic rental escalations averaging 2-4% p.a.

Upgrade to ACCUMULATE, DDM-based TP raised from S$2.91 to S$3.20

Changes from our previous report

Our DDM-based TP has been raised to reflect higher occupancy and asset productivity following AEI, which raises our NPI by 6.9% on a same store basis (excluding any acquisition assumption). Our previous TP of S$2.91 assumes that KDC will make a S$500mn of acquisitions in 1Q21e (NPI yield 6% and LTV 30%). In this report, we push back our S$500mn acquisition assumption (NPI yield 6% and LTV 30%) from 1Q21 to 4Q21.

Scenario analysis: with and without acquisitions

Our acquisition assumption reduces FY21e DPU by 5.4% due to an enlarged share base, but increases FY22e DPU by 5.3% (Figure 1).

Demand for data centres is supported by increasing 5G, smartphone and cloud adoption. KDC’s higher P/NAV of 2.4x (Figure 3) is supported by the forecast growth in data centres and its ability to deliver earnings growth through AEI, rental improvements and accretive acquisitions. We forecast DPU yields of 3.3%/3.8% for FY20e/21e, which should deliver a forward yield spread of 220bps, the average of its five-year historical yield spread over 10YSGS (Figure 2).

• 9M20 DPU of 6.73 cents in line, forming 71.3% of our FY20e DPU estimate.
• Portfolio metrics healthy: long WALE of 7.2 years, portfolio occupancy of 96.7% and interest coverage ratio of 12.7x. AEI and rental escalations to provide organic growth.
• Reiterate NEUTRAL with a higher DDM-based target price of S$2.91 from S$2.57 after incorporating S$500mn of acquisitions for 1Q21e. Despite strong metrics and future-ready asset classes, reiterate Neutral as we believe the market has priced in potential catalysts from acquisitions and STI inclusion. Prefer Ascendas REIT (AREIT SP, Accumulate, TP: S$3.63) in the sector.

The Positives

• 3Q20 DPU grew +22.1% YoY. This was mainly driven by its acquisitions of KDC SG 4 and DC1 in 4Q19 and Kelsterbach DC in March 2020, tax savings from attainment of tax transparency for KDC SG 4 and higher rents charged on the conversion of non-DC space to DC at KDC SG 5. DPU was up 16.5% YoY in 9M20. KDC has several AEIs underway (Figure 1), which should continue to drive revenue.
• Strong leasing quarter, occupancy inched up from 96.1% to 96.7%. KDC Dub 1’s Asset Enhancement Initiative (AEI) was completed despite a 2-month delay to bring more power onsite. Occupancy increased from 63.3% to 81.1% upon the power upgrade. The space has been leased to a new telco tenant. Despite large take-up of 12,125 sq ft, no discounts were offered. Client expansion at KDC SG 1 is expected to lift occupancy from 89.2% to 91.0% (1,975 sq ft) and from 93.5% to 98.2% (1,809 sq ft) at KDC SG 2, both of which commenced on 1 October 2020. KDC also managed to secure an early lease renewal for its iSeek Data Centre in Australia, terming out its iSeek’s WALE from six years to 10.7 years.

The Negatives

• AEIs and development completions pushed to 1H21; intermittent disruptions. Most of KDC’s AEIs was disrupted by construction delays due to COVID-19 lockdowns in 1H20. Client fit-out at DC 1 has also been delayed to 1H21. While construction has resumed, delays in certain supplies and manpower scheduling have resulted in intermittent disruptions.

Outlook

Still awaiting acquisitions. KDC is still negotiating several third-party deals with cap rates of 4-7%, some in advance stages. However, its deal process has been stalled by travel restrictions. Management shared that the number of deals and size have increased. While demand for data centres has compressed cap rates, asking prices for deals under negotiation are unchanged.

Demand-supply gap to lift market rents. Demand-supply gaps exist in many markets due to government restrictions on the supply of data centres. Globally, demand for data centres is being driven by big data, 5G and cloud adoption. Singapore has attracted Chinese tech companies looking to set up headquarters and operations here to perform big data analytics. We understand, however, that the Chinese tech players were unsuccessful in securing land from the government for data-centre development. Given the moratoriums on data centres in Singapore, we expect market rents to be bid up in the coming two years. While KDC’s high portfolio occupancy of 96.7% and long WALE of 7.2 years translate to low expiries in 2021/22 and leave little opportunity for positive rental reversions, many of its existing leases and co-location arrangements have built-in periodic rental escalations averaging 2-4% p.a.

Maintain NEUTRAL with higher target price of S$2.91, from S$2.57.

Our DDM-based TP has been raised from S$2.57 to S$2.91 following our assumption of S$500mn of acquisitions with an NPI yield of 6% and LTV of 30% for 1Q21e. This translates to DPU accretion of 5.0%/ 5.8% for FY21e/FY22e and gearing of 35% in FY21e. Despite strong portfolio metrics and future-ready asset classes, we reiterate our Neutral view as we believe the market has priced in potential catalysts from acquisitions and STI inclusion. KDC is trading at an all-time high and DPU yield of 3.1%/3.6% for FY20e/21e is not compelling. Prefer Ascendas REIT (AREIT SP, Accumulate, TP: S$3.63) in the sector.

• 1H20 DPU of 4.375 cents was in line, forming 49% of FY20e DPU estimates.
• Portfolio metrics healthy – long WALE of 7.4 years, portfolio occupancy at 96.1% and AEIs to drive revenue growth.
• Reiterate NEUTRAL with a higher target price of $2.57 (previously $2.31). We raised our terminal growth rate assumption from 1.5% to 2.0% to better reflect KDC acquisition-driven 5-year DPU CAGR of 2.7%. While we like KDC for its strong portfolio metrics and future-ready asset class, we think that upside is limited given the strong rally in prices and yields at c.3%, which are not compelling.

The Positives
+ No out-of-pocket rental rebate to tenants but passed on the property tax rebates by the government to Singapore tenants. All tenants remain current with rents.

+ $2.8mn tax savings p.a. upon attainment of tax transparency for KDC 4. KDC 4 attained of tax transparency status on 25 May 2020, which will result in some $2.8mn worth in tax savings. An extended land lease title at KDC 4 by 30 years till June 2050 (cost $5mn). Despite some anticipated delays, the tax transparency status was attained within c.7 months after acquisition on 31 October 2019, within the estimated 6 to 9-month gauge based on past application.

+ Early lease renewal negotiations reduced FY21 expiries from 10.75 to 6.2% by NLA as at end-June 2020. The REIT has 2.6% of total net lettable area (NLA) up for renewal in 2H 2020. The Manager has started engaging clients for early renewals and brought down the total NLA due for expiry in 2021 from 10.7% as at end 2019 to 6.2% as at 30 June 2020.

The Negatives

- Delay in AEI and development timelines due to lockdowns. KDC has several AEIs ongoing – Dub 1 (increase energy efficiency, TBC 2H20), KDC SG 5 (conversion of 15.8% NLA from non-DC space to DC), DC1 (fit out of shell & core space, TBC 1H21) and the development of Intellicentre 3 (delayed from 4Q20 to 1H21). AEIs for Dub 1 and Dub 2 have resumed following a 2-month lockdown, however construction works in Singapore remain suspended due to government policies on foreign workers residing in dormitories. While development works in Australia were allowed to continue through the pandemic, delay in certain supplies may result in delays.

- Gearing increased from 30.7% to 34.5% as at 30 June 2020, as expected, due to acquisition of Kelsterbach DC (Germany, TBC 1H20) and the balance of the 999-year land lease for KDC Dub 1. However, with KDC‘s strong balance sheet and high-interest coverage ratio of 12.8x, we view this utilisation of gearing headroom favourably.

Outlook
Acquisition timeline thwarted by travel restrictions. KDC is negotiating several third-party deals, some of which are in advanced stages. However, travel restrictions have made asset viewing impossible. Increase in potential buyers may lead to bidding-up of prices.

Maintain NEUTRAL with a higher target price of $2.57 (previously $2.31)
In the 5 years since listing, KDC has grown DPU at a CAGR of 2.7%. Our previous DDM assumptions incorporated a 1.5% terminal growth rate which is below the historical pace of DPU growth. Our change in TP is attributed to a higher terminal growth of 2.0% incorporated (prev. 1.5%). In light of the increased competition for assets, we have assumed a more tapered terminal growth rate of 2.0% (vs. the historical CAGR or 2.7%). Based on our FY20e DPU of S$0.90, DPU yield of 3.3% is on the low side while P/NAV of 2.26x

• 1Q20 DPU of 2.08cents was in line, forming 23% of FY20e DPU estimates
• Portfolio metrics healthy – long WALE of 8.3 years, portfolio occupancy at 94.7% - and AEIs to drive revenue growth.
• While we like KDC for its solid portfolio and future-ready asset class, we think that upside is limited given the strong ride up in prices, and yields at c.3%, are not compelling. We recommend accumulating on pull back.
• Downgrade to HOLD with a higher target price of $2.20 (previously $2.06). We adjusted our estimates upwards while lowering the cost of equity by 100bps to reflect the lower interest rates, and lower beta slightly as we believe the data centre asset class should be less sensitive to market factors.

The Positives

• Solid operating metrics. KDC has an interest coverage of 12.8x. Their low gearing of 32.2% affords KDC a debt headroom of S$377mn. Demand for data centres remains strong and higher data traffic is expected due to telecommuting during the COVID-19 lockdown.
• Occupancy at KDC SG 5 fully committed, up from 84.2%. KDC SG 5 is currently undergoing AEI to convert 15,450 sqft (15.8%) of vacant, non-DC space to DC. This will allow KDC to command higher rentals. The space has since been fully committed with completion of the AEI expected in 2H20.

The Negatives

• Delay in AEI and development timelines due to lockdowns. KDC has several AEIs ongoing – Dub 1 (increase energy efficiency), KDC SG 5 (conversion of 15.8% NLA from non-DC space to DC), DC1 (fit out of shell&core space) and the development of Intellicentre 3 (delayed from 4Q20 to 1H21). Delays in completion of AEIs are due to the lockdown (and subsequent extensions) in Singapore, Ireland, and Australia. AEI completions will be delayed by 4 to 6 weeks for Ireland and c.8 weeks for Singapore.
• Higher financing costs due to wider spreads. KDC has been enjoying favourable interest rates at 1.7%. Despite the lower interest rate environment, credit spreads have widened due to increased business risk – KDC expects all-in debt cost to increase by 20 to 30 bps upon refinancing. Regardless, KDC’s credits spreads are still below 100bps and the REIT has only 6.7% of debt maturing in FY20.
• Occupancy at KDC SG 2 fell from 100% to 93.5% upon renewal of the lease. Downsizing was due to the end tenant’s user not renewing services. However, the management shared that the remaining space was renewed on a longer lease term.

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.

• 3Q19 NPI and DPU were in line with our estimates. 9M DPU formed 74.2% of our FY19 estimates
• Portfolio metrics healthy; occupancy crept up 0.7% ppts and while post-acquisition gearing will settle at 30.3% (historical average 30.7%)
• Maintain ACCUMULATE with a higher target price of $2.06 (previously $2.00). We raise our estimates by 2% to reflect the tightening DC market which will help provide support for rents

The Positives

• Ramp-up in operations was more than able to make up for the income support falling off. The rental support for KDC SG 5, KDC Dub 2 and Milian DC were fully utilised as at 2Q19. Management commented that the ramp-up stabilisation of these assets surpasses the rental support previosuy drawn.
• Portfolio occupancy improved 0.3ppts QoQ from 93.2% to 93.6%. This was due to new leases signed at KDC SG 1 (+0.7ppts) and KDC Dub 1 (+3.9ppts). Post-retrofitting, KDC Dub 2’s occupancy increased 9.3ppts to 100%.
• Refinanced all loans maturing in 2019 with a 6 year term loans. All-in cost of borrowing expected to be unchanged at c.1.7%.

The Negatives

• No improvement in stubborn vacancy rate at Basis Bay DC (Malaysia). Occupancy has remained at 63.1% for the last 10 consecutive quarters.

Outlook

Vacant, non-DC NLA poses potential for conversion to data centre (DCs), making KDC a beneficiary of tapering DC supply in Singapore. Currently, 22,178 sqft of NLA - 6.4% and 15.8% from KDC SG 1 and KDC SG 5 - are non DC space. KDC is in the midst of getting government approval to bring more IT power onsite to convert the space at KDC SG 5 to DC space.

Maintain ACCUMULATE with a higher target price of $2.06 (previously $2.00)

We raise our estimates by 2%  to reflect the strong demand for DCs admist the tightening DC supply. Our TP of $2.06 implies a 3.8%/4.46% FY19e/FY20e DPU yield.

• 1Highly accretive proposed acquisition of 99% stake in KDC4 and 100% stake in 1NN will increase DPU by c.12.4% and AUM by 30.7%.
• FY19e DPU to fall 0.42 cents from 7.98 cents to 7.56 cents due to the enlarged unit base while FY20e DPU will increase 0.37 cents from 8.33 cents to 8.70 cents, translating to DPU growth of 15.1% in FY20.
• 6x P/NAV is well supported; private placement of S$235.4mn was 9.3 times subscribed.
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A look at the assets

• Acquisition of KDC4 and 1NN for agreed value of S$384.9mn and S$200.5mn respectively.
• Equity fund raising grossed S$473.8mn comprising of a S$235.4mn private placement tranch and S$242.8mn preferential offering. The private placement was 9.3x oversubscribed. 91.7% of proceeds will be used to fund the acquisition, implying a 80:20 equity-to-debt ratio.
• Proposed acquisition is subject to a shareholder vote. The EGM is likely to take place in end-October/early-November, with deal headed towards a end-November completion.
• Acquisition will increase the AUM in Singapore from 51.1% to 62.7%.

Keppel Data Centre 4 (KDC4) – S$384.9mn

• Proposed acquisition of 99% interest in KDC4, a five-story colocation asset with NLA of 84,544 sq ft. KDC4 has committed occupancy of 92% and is located in Tampines.
• Pro forma DPU accretion ranges from 4.1% - 7.5% (figure 1 and 2), the higher-end accretion is contingent on IRAS’s approval of the REIT tax transparency status for the KDC4 target entity.
• KDC4 is a 2-year-old asset which is currently under stabilization. As revenues are driven by the amount of power utilised by the tenants, rental support of c.$8.8m has been negotiated to cover the 24-month period after completion of the sale to provide rental top-ups during the initial period as clients progressively power up their racks. The rental top-ups will ensure that KDC will receive a NPI yield of at least 7% during the initial 2 years. The stabilised NPI yield for KDC4, given current 92% occupancy, will be 7.5%.
• At the current committed occupancy of 92%, KDC4's stabilised NPI yield stands at c.7.5%. As all the IT power is fully committed, additional Capex will be required to bring more power onsite in order to lease out the remaining 8% of space as data centres. Alternatively, the remaining space could be leased out as ancillary office space.

1-Net North Data Centre (1NN) – S$200.5mn

• Proposed acquisition of 100% interest in 1-Net North Data Centre (1NN), a five-story triple-net master-leased asset with NLA of 213,815 sq ft.
• First assets located in the North (Woodlands) and provides diversification; while master lease provides income visibility and stability.
• Of the five floors, four are data centres (DC) and the remaining floor is comprised office and ancillary space.
• 1NN’s NPI yield of 9% will provide DPU accretion of 6%
• 100% occupied on a 17 + 7.6 year lease term.

Impact on KDC

• Significant DPU accretion from 9.4% - 12.4%.
• Stronger portfolio: Better diversification across lease types (figure 3 and 4); WALE will be increased to 8.9 years from 7.8 years; and portfolio occupancy will improve form 93.2% to 94.1%. Leverage will fall 160bps from 31.9% to 30.3%.
• Greater leasing synergies and operational efficiency due to economies of scale given close proximity of KDC4 to KDC2 and KDC3.

What do we think?

A highly anticipated, well-timed and positive move. The proposed acquisition is highly accretive and results in a stronger enlarged portfolio as well as better financial metrics.

Outlook

The announcement of the dual acquisition comes hot on the heels of KDC’s inclusion into the FTSE EPRA NAREIT Developed Index. KDC’s rich valuation of 1.6x P/NAV is well supported given the added visibility from index inclusion, their niche portfolio of data centres and track record of acquisition-driven DPU growth.

Despite the sizable two-asset acquisition, acquisitions within the next 12 months are still a possibility as discussions with several third-party sellers have been underway since the start of 2019.

Key risks

The key risk remains the attainment of the tax transparency status for the entity holding KDC4. KDC successful attained tax transparency status for KDC1, KDC2, KDC3 and most recently KDC5 in January 2019 (acquired 12 June 2018). The confirmation of tax transparency is expected to be announced between 6 – 9 months after application.

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KDC’s cost of funds have been falling steadily since listing (FY15/FY17/2Q19 2.5%/2.3%/1.7%). We lower our cost of equity assumption by 48bps from 6.99% to 6.51% to reflect the lower risk-free rate.

We adjust our forecast to incorporate the proposed acquisitions and the lower cost of equity assumption. Our target price translates to a FY19/FY20 DPU yield of 3.8%/4.4% and a FY19 P/NAV of 1.64x.