Brokers' take: UOBKH initiates 'buy' on Digital Core Reit with US$1.18 target price

UOB Kay Hian (UOBKH) U10 has initiated coverage on Digital Core Reit DCRUw : DCRU 0%ith a "buy" call, as it sees the pure-play data centre real estate investment trust (Reit) as a key beneficiary to a projected growth in demand for hyperscale data centres in coming years.

Hyperscale data centres are used by technology giants such as Amazon, Facebook, Google, IBM and Microsoft, who dominate the cloud services industry. These hyperscalers utilise the data centres to support hundreds of millions of users.

Digital Core Reit is sponsored by Digital Realty, one of the largest owners, operator, developer and acquirer of data centres globally. The Reit has an initial portfolio of 10 institutional quality freehold data centres located in the United States and Canada, with an aggregate appraised value of about US$1.4 billion and 100 per cent occupancy rates.

The research team has a target price of US$1.18 on the counter, based on a dividend discount model. It noted that Digital Core Reit is trading at 1.2 times its net asset value, a "huge discount" compared with other data centre Reits.

UOBKH’s target price of US$1.18 represents a potential upside of 2.6 per cent from the Reit’s closing price of US$1.15 on Tuesday (Dec 7). The counter was up 13.86 per cent or US$0.14. The Reit commenced trading on the Singapore bourse on Monday.

Furthermore, UOBKH said Digital Core Reit provides a distribution yield of 4.4 per cent for 2022, which is more attractive compared with an average of 2.3 per cent for its peers listed in the US.

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"It deserves a more compressed distribution yield relative to other S-REITs due to its status as a pure play on data centres and (the potential for) acquisition-led growth with support from Digital Realty," the team added.

In a research note on Tuesday (Dec 7), UOBKH said demand for hyperscalers is expected to grow at a compound annual growth rate (CAGR) of 23 per cent in 2020 to 2024. This outpaces a CAGR of 15 per cent for the broader North America data centre market.

Digital Core Reit had 12 customers, which are Fortune 500 and multinational companies, on its books as of June 2021. The Reit's top six tenants have been customers of its sponsor Digital Realty for more than 15 years; contributing to a high tenant retention rate of 95.8 per cent.

"Tenants are entrenched due to capex incurred and high switching costs," UOBKH said.

Digital Core Reit has also benefited from strong demand for hyperscale data centres with 68.5 per cent of its base rental income deriving from hyperscale segment, the research team noted.

UOBKH said Digital Core Reit's ability to scale up through acquisitions is supported by its low aggregate leverage of 27 per cent and its more competitive cost of debt of 1.0 per cent. Sponsor Digital Realty has granted the Reit a global right of first refusal on its growing data centre pipeline worth over US$15 billion.