Keppel DC REIT – Only if the price is right April 24, 2020 514

PSR Recommendation: NEUTRAL Status: Downgraded
Last Close Price: S$2.57 Target Price: S$2.200
  • 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.

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Natalie Ong
Research Analyst
Phillip Securities Research

Natalie covers the REITs and Property sector. Previously a business analyst with a management consultancy, she handled feasibility studies and business optimisation and restructuring projects. She has worked with companies from varied industries including logistics, FinTech, EduTech, gaming, F&B and retail. She graduated with a Bachelor of Science (Honours) in Banking & Finance from the University of London.

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