Brokers' take: UOBKH downgrades Digital Core Reit to 'hold' on rising cost of debt

UOB Kay Hian (UOBKH) has downgraded Digital Core Reit (DC Reit) from “buy” to “hold” on concerns over rising cost of debt.

This comes after DC Reit on Thursday (Apr 21) posted US$12.1 million in first-quarter distributable income, beating its initial public offering (IPO) forecast of US$11.9 million by 1.9 per cent. 

In a report issued on Friday, UOBKH’s Jonathan Koh said the Reit’s cost of debt is expected to increase from 1.2 per cent in Q1 2022 to 2.1 per cent in Q2 2022. 

Assuming that the Fed Funds Rate averages 2.5 per cent, he estimates DC Reit’s average cost of debt will increase to 3.2 per cent in FY2023. This has resulted in a 9 per cent lower FY2023 distribution per unit (DPU) forecast to 4.7 US cents. 

UOBKH’s target price on the Reit has subsequently been lowered to US$1.10 from US$1.32. 

Also to account for higher borrowing costs, DBS Group Research has lowered the target price to US$1.30 from US$1.40, but maintained its “buy” call.

Assuming US$250 million of debt-funded acquisitions in FY2022 and a further US$500 million of acquisitions funded by both debt and equity in FY2023, DBS’s research team expects these to drive a 3-year DPU compound annual growth rate of around 5 per cent over FY2021 to FY2024. This is 4-6 per cent above the real estate investment trust’s (Reit) IPO forecasts.

On the bright side, both UOBKH and DBS note that the Reit’s portfolio remains resilient, with full occupancy for all 10 data centres, a long weighted average lease expiry of 5.5 years and a conservative gearing level. 

UOBKH’s Koh estimates a debt headroom based on aggregate leverage of 35 per cent at US$188 million. 

Noting that DC Reit provides a lower FY2023 distribution yield compared to its peers Keppel DC Reit and Mapletree Industrial Trust , Koh believes DC Reit “deserves to trade at a premium” given its status as a pure play on data centres. 

While the bankruptcy of DC Reit’s fifth-largest tenant is unexpected, he notes that not only is the tenant current on its rental obligations, the Reit’s sponsor, Digital Realty, guarantees the rental income stream in the event of cash flow shortfall due to the customer bankruptcy. 

DBS’s research team said the strong commitment from its sponsor could make DC Reit one of the largest S-Reits. Digital Realty has granted DC Reit a right of first refusal to some US$15 billion worth of data centres globally, and has a further US$5 billion worth of data centre developments that could potentially be made available to DC Reit when completed.

As at 3.54 pm on Friday, units of DC Reit were trading at US$0.97, down 5.83 per cent or US$0.06.