DBS lowers Keppel DC Reit’s target to S$2.40 on reduced earnings estimates

DBS Group Research on Friday (Jun 3) lowered Keppel DC Reit’s target price to S$2.40, after cutting its estimates to account for increasing utility costs and interest rates, and the partial default by DXC Technology.

Despite cutting its target price, the research team said Keppel DC Reit’s 5 per cent yield in its FY2022 estimates were “too attractive to ignore”. It has maintained its “buy” call on the data-centre focused real estate investment trust (Reit).

Keppel DC Reit’s new target price implies a target yield of between 4.2 per cent and 4.5 per cent over the next 3 years, which DBS believes is fair as Keppel DC Reit offers growth – although at a slower pace.

It also represents a potential upside of 18.2 per cent from the counter’s Thursday’s trading price of S$2.03 as at 3.30 pm. The counter was up S$0.04 or 2 per cent at the time.

While accretion from its recent acquisitions have offset increasing operating costs, DBS believes that the bulk of these impacts have “already been felt and factored into the current share price”.

That being said, DBS estimates a partial loss of income from Keppel DC Reit’s litigation suit against DXC for a partial default of rental payment. The amount disputed is around S$14.8 million.

As legal proceedings tend to be long drawn out, the research team has assumed there will be an absence of S$3.7 million in revenues per annum in the next 3 years.

DBS also believes that higher operating costs from increasing utility costs and rising interest rates will pose risks Keppel DC Reit’s near-term earnings. However, the Reit’s interest rate exposure is substantially hedged, with about 76 per cent of Keppel DC’s borrowings hedged to fixed rates.

In the medium term, foreign exchange volatility may have some impact on earnings. As Keppel DC Reit typically hedges its income in foreign currencies by up to 2 years in advance, such volatility will likely only be felt in the later half of FY2023, the report noted.

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The research team has lowered its distribution per unit projections by 7 per cent over the next 2 years, after revising its earnings estimates to take into account the partial default and higher operating costs.

In a separate sector report, DBS noted that the price correction of data-centre-focused S-Reits provides an opportunity to “buy growth at attractive prices”.

“We remain convinced that data centres remain the ‘oil’ for the digital world post Covid-19, with demand exceeding supply, which translates into a continuously tight transaction market with improving operating metrics,” said DBS analyst Dale Lai.

He noted that yields for 4 data-centre-focused S-Reits have expanded to more than 5 per cent on average after the most recent price correction. The market also appears to have discounted the “superior growth” these Reits offer to investor, especially when selected S-Reits have significant pipelines that can be acquired from their respective sponsors.

Keppel DC Reit, along with Digital Core Reit, stands out as DBS’s preferred plays in its value metrics, as they have sponsors which are both owners and operators of data centres.

Meanwhile, Ascendas Reit and Mapletree Industrial Trust provide diversified exposure to a wider “new economy” spectrum of assets, but with a more steady but sustainable growth profile.