REITs

REIT analysis: Keppel DC REIT (SGX: AJBU) (Updated 18 Apr 2021)

Keppel DC REIT featured image

On the back of my previous analysis post about Mapletree Industrial Trust, I will be following up with another analysis post.

This time, I will be looking at Keppel DC REIT (KDCR).

In recent times, KDCR has garnered significant interest from retail investors. This is possibly due to the digitalization process that many companies are currently undergoing, leading to a huge demand for data centres.

Thus, it is no surprise that KDCR’s share price has been on an upward trend since its IPO.

While there has been some pullback from its all-time high, IPO investors would still be looking at returns of at least 200% (including dividends) based on the current market price.

Given KDCR’s impressive performance since its IPO, I thus decided to analyse it and see if it would be a good addition to my portfolio.

Do note that I will only be using data from KDCR’s past five financial years for this analysis.

Disclaimer: This post is mainly for education and sharing purposes. It should not be seen as a recommendation to buy or sell a stock. Such decisions should be made on the reader’s own personal accord, after doing their due research. As such, I take no responsibility for any future loss or gain resulting from the purchase or sell of this stock. I also do not currently own any shares in KDCR.

Business overview

As a REIT, KDCR derives its income from the leasing and management of data centres.

There are 3 main types of data centres in KDCR’s portfolio, namely colocation, fully-fitted and shell and core.

  • Colocation data centres – Colocation data centres are typically leased out to multiple clients. Such leases comprise both short-term retail leases or longer-term wholesale lease to bigger companies.
  • Fully-fitted data centres – These data centres are ones that are fully equipped to deal with all forms of network demands. For KDCR, most of its fully-fitted data centres are purpose-built for particular clients.
  • Shell and core – Similarly to fully-fitted data centres, KDCR’s shell and core are also purpose-built for clients. The difference is that shell and core data centres only contain the skeletal requirements to run a data centre. Thus, the mechanical and electrical infrastructure required for extensive networking demands is not provided by KDCR.

Currently, KDCR has a portfolio of 19 data centres, excluding one which is under development. Of it, nine are colocation data centres while the remaining data centres are either fully-fitted or shell and core data centres, which are master leased to KDCR’s clients.

Of the ten master leased data centres, KDCR either has a double or triple-net lease agreement with the clients. This means that KDCR does not have operational control over the data centres, thereby reducing the overall operating expenses of the REIT.

Revenue segments

When it comes to KDCR’s overall revenue, a huge chunk of it comes from the colocation data centres.

As of FY2020, colocation data centres contributed to around 71% of KDCR’s overall revenue. This means that KDCR’s revenue can be subjected to some volatility due to the shorter leases in colocation data centres as compared to fully-fitted or shell and core data centres. However, over the past 5 years, this shorter lease nature has had little impact on KDCR’s growth.

As seen, the CAGR of revenue from colocation data centres has grown at an impressive 29.3%. Furthermore, revenue from colocation data centres also witnessed consecutive year-on-year growth in the past 5 years. This shows that despite the shorter lease years, KDCR was still able to comfortably grow its revenue from colocation data centres.

Moving on to the geographical revenue segment of KDCR, much of the overall revenue originates from Singapore.

As seen, revenue from Singapore took up close to 61% of KDCR’s FY2020 overall revenue. This is not really a surprise given that 5 out of 9 of KDCR’s colocation data centres are located in Singapore.

In addition, revenue contribution from Germany has also increased slightly from FY2019. This is mainly due to the revenue contribution from the Kelsterbach data centre which KDCR acquired in mid FY2020.

Having briefly examined KDCR’s business model, I will now move on to what I like about it.

What I like about KDCR

Impressive top and bottom-line growth

Looking at its results for the past 5 years, KDCR has really impressed me with its top and bottom-line performance.

As seen, gross revenue, net property income and distributable income all recorded CAGR of double digits. Also, we can see that FY2020 has been a great year in terms of financial results for KDCR. This is possibly due to the increased rate of companies embracing digitalisation as a result of the Covid-19 pandemic.

With demand for online data space not going away any time soon, I expect KDCR to maintain its double digit growth, at least in the near future.

Positive returns for unitholders

Besides having double digit growth in its top and bottom line, KDCR has also steadily provided positive returns for its unitholders.

In the past 5 years, there has been year-on-year growth in KDCR’s DPU and NAV. This is good news for unitholders as they are both being paid more dividends and at the same time owning a REIT that increases in value over time.

While KDCR’s growth in DPU and NAV has been impressive, the same cannot be said of KDCR’s AFFO per unit.

From the chart above, we can see that KDCR’s AFFO per unit has been patchy over the last 5 years, despite its overall CAGR being a positive value. In addition, KDCR’s AFFO per unit was actually decreasing from FY2017 to FY2019. While this might set off some alarm bells, I do feel that there is nothing much to worry about.

The decline in KDCR’s AFFO per unit for FY2018 and FY2019 is mainly due to its rights issue. Without it, AFFO per unit for FY2018 would have increased from the previous year.

However, AFFO per unit for FY2019 would still see a significant drop. The drop in FY2019 could have been a result of asset enhancement initiatives (AEI) that KDCR undertook for some of its data centres, leading to lesser income-generating avenues and increased capital expenditure.

Given that AFFO per unit has since recovered in FY2020, I am optimistic that AFFO per unit would continue to grow with KDCR’s future acquisitions.

Sustainable debt profile

In addition to its impressive financial results, KDCR also score high points in terms of debt management.

Straight off the bat, KDCR has an insanely high interest coverage. In fact, with an interest coverage of 13.3 times, KDCR is amongst one of the highest in the S-REIT market. This means that bar any exceptional circumstances, KDCR should have no problems fulfilling its debt repayments.

In addition, KDCR’s cost of debt has also been decreasing over the years. This is to be expected given the current relatively low-interest-rate environment. While the average debt tenor has decreased slightly in FY2020, I still find 3.2 years to be reasonably alright.

Besides a lower average debt tenor, KDCR’s aggregate leverage has also shot up to 36.2%. While there was a huge spike between FY2019 and FY2020, KDCR’s current aggregate leverage still provides ample debt room before hitting the regulatory limit. Furthermore, the rise in leverage levels is also due to the acquisitions that KDCR made in FY2020.

All things considered, in terms of debt profile, I do not see any near term financial woe for KDCR. As long as KDCR continues to grow sustainably, it should not have any issues in terms of managing its debt.

High portfolio occupancy and long WALE

In addition to stellar financial performance, KDCR also has a healthy property portfolio.

As seen, KDCR’s total portfolio occupancy comes in at 97.8% for FY2020. In addition, KDCR has also experienced year-on-year increases in its portfolio occupancy since FY 2017.

If we were to focus purely on colocation data centres, occupancy rates also look quite impressive.

KDCR portfolio occupancy rate

As seen, 7 out of KDCR’s 9 colocation data centres had occupancy rates of more than 90%, with 4 being at full occupancy. The sharp increase in occupancy rates of Keppel DC Singapore 5 and Keppel DC Dublin 1 from FY2019 to FY2020 was due to the completion of asset enhancement works and the subsequent moving in of clients.

Out of KDCR’s entire colocation data centres portfolio, the only laggard data centre I feel would be Basis Bay Data Centre. This is mainly due to the stagnation of its property occupancy rate over the years.

Having said that, Basis Bay Data Centre currently only makes up 1.2% of KDCR’s AUM. Hence, even with its relatively low occupancy rate, it does not have a significant impact on KDCR’s revenue and earnings.

Moving on from occupancy rate, KDCR’s WALE for FY2020 stood at 6.8 years.

As seen, much of KDCR’s WALE can be attributed to leases for its fully-fitted and shell and core data centres.

Over the past 5 years, KDCR’s overall WALE has been on a declining trend. However, as a comparison to other REITs in the market, 6.8 years is still relatively long.

In addition, KDCR’s lease expiry profile is also quite healthy in the near future.

As seen, only around 14.3% of leased area is up for renewal over the next two years. Given that data centre clients are often sticky in nature due to the required investment cost in servers and racks, KDCR should not have issues in negotiating renewals for most of its clients.

In the worst-case scenario that none of these clients renewed their leases, KDCR should have no difficulties in attracting new clients given the continual demand for data centre space.

Resilient revenue with growth opportunities

In addition to KDCR’s stellar portfolio performance, I also like the fact that it is a pretty resilient REIT.

As observed during the Covid-19 pandemic, KDCR’s earnings were not hugely affected at all. In fact, KDCR posted one of its highest growth in FY2020. This is in line with the growth trend observed in the global data centre industry.

In addition, as we advance on to 5G and Internet of things (LOT), data centres would become the backbone of the new digital era, due to the immense need for data and connectivity. Furthermore, digitalisation efforts by SMEs would also provide opportunities as they look to cloud operators to minimise cost. This puts KDCR in good stead as cloud operators make up a bulk of the clients for colocation data centres.

Lastly, the relative long WALE of KDCR’s portfolio also means that there will be lesser potential income disruptions.

Relatively strong sponsor

If it was not already obvious, KDCR is part of the Keppel conglomerate. KDCR’s sponsor, Keppel Telecommunications and Transportation (Keppel T&T) is a wholly-owned subsidiary of Keppel Corp.

More importantly for KDCR, Keppel T&T has access to a portfolio of roughly 28 data centres in 19 cities, spanning both the Asia Pacific and European regions. This is extremely important for KDCR moving forth due to the prospect of the Singapore data centre market, which I will touch on more in later parts of the post.

Additionally, having been granted Rights of First Refusal for future acquisition of Keppel T&T’s data centres, KDCR also has a pipeline of potential acquisitions from its sponsor.

All in all, over the past 5 years, KDCR has shown that it is a financially resilient REIT with growth opportunities and a great financial performance to boot.

Points to consider for KDCR

While there is much to like about KDCR, I also came across a few aspects which warrant a second look. I would not consider these aspects as negative per se, rather they should be points for consideration before investing.

Relative high dividend payout ratio

When it comes to dividend payout ratio for REITs, I always like to compare it to the REIT’s AFFO. Doing so allows me to see if the dividends can be sustained by the REIT’s operations or not.

In the case of KDCR, its dividend payout ratio is on the high side.

As seen, over the past 5 years, KDCR’s dividends exceeded its AFFO on one occasion in FY2019. Furthermore, FY2020’s dividend payout of 93.8% can also be considered to be rather high.

Having said that, outside of the last two financial years, KDCR’s dividend payout ratio from FY2016 to FY2018 has actually been quite alright. Generally, as long as dividends paid out do not consistently exceed a REIT’s AFFO, the dividend can be considered to be sustainable.

Nevertheless, unitholders should still monitor this figure in the years to come.

Near-term refinancing obligations

When it comes to KDCR’s debt maturity profile, it is definitely not very well spread out at all.

As seen, around 28.1% of KDCR’s total debt matures in the next 2 years, 12.3% in 2021 and 15.8% in 2022. Including both years, it works out to around 327.6 million based on KDCR’s total debt of 1.17 Billion.

Having said that, based on KDCR’s balance sheet for FY2020, I do not foresee there being any issues in refinancing or paying off the debt maturing in the next two years.

As of FY2020, KDCR had cash and equivalents of 244.4 million. This far surpasses the 143.4 million that is maturing in 2021. Furthermore, KDCR’s current aggregate leverage percentage allows the REIT room to refinance the maturing debt or take on more debt to better spread out the maturity profile.

Should KDCR take up more debt, there is a possibility that its NAV might decrease.

However, all these still remain as mere speculation. Only time will tell what KDCR does to refinance its upcoming debt.

Short-term rental disruption risk

Although only a small percentage of KDCR’s net leased area is up for renewal in the coming years, they represent a significant portion of KDCR’s rental income.

Source: Keppel DC REIT FY2020 annual report

As seen, leases accounting for around 47% of KDCR’s rental income would be up for renewal in the next two years. Should these leases not be renewed, KDCR’s rental income would definitely take a significant hit.

Having said that, there is no indication that KDCR would face trouble with renewing these leases. I also doubt that KDCR’s management has no backup plan should a worst case scenario happens. Nevertheless, investors should still keep an eye up for future business updates regarding KDCR.

Concentration risk

Another aspect to note for KDCR is its apparent concentration risk in rental income and revenue.

Source: Keppel DC REIT FY2020 annual report

As seen, much of KDCR’s rental income comes from the internet enterprise sector. KDCR’s top ten tenants also contributed to 80% of KDCR’s total rental income for FY2020.

While having internet enterprise as a significant sector is not surprising given the required networking demands, I was slightly surprised that one sole tenant contributed 40.4% of KDCR’s total rental income. This is extremely risky as a huge void needs to be filled should that one client choose not to renew its lease with KDCR.

As mentioned earlier in this post, majority of KDCR’s revenue comes from Singapore. In fact, revenue from Singapore has grown at the highest rate as compared to other regions which KDCR has a presence in.

The continued reliance on Singapore as a major source of revenue for KDCR is a double-edged sword. On one hand, Singapore remains an attractive location in the data centre market, hence there would be no shortage of potential clients. On the other, there are definitely constraints in Singapore that could hamper the growth of KDCR.

Potential stagnation in Singapore

It is no secret that land space is scarce in Singapore. Thus, new data centres cannot be continually built for Singapore to retain its edge as a prominent data centre player in the region. This is in contrast to neighbouring countries where land is more freely available for the development of data centres. As such, Singapore could be priced out of potential clients in the long term.

Furthermore, there is also the issue of sustainability to consider.

Given that data centres rely on a huge amount of power to function, building more data centres would fly in the face of Singapore’s commitment to the Paris Climate Accord. Thus, it was not surprising when the government hit the pause button in the building of new data centres.

With the dual constraint of land space and sustainability, inorganic growth (via the building of new data centres) would be subdued. This minimises potential growth opportunities in Singapore for KDCR.

However, not all is lost.

Keppel Data Centres Holdings, the data centre arm of Keppel T&T, is looking at developing a floating data centre park in Singapore. If successful, this could be a potential growth avenue for KDCR in the future.

In addition, utilisation rate of data centres in Singapore has yet to hit its peak.

Source: Keppel DC REIT FY2020 annual report

As seen, despite the prominence of Singapore as a data centre location, utilisation rate of data centres is expected to decrease over the next 4 years. This signifies that there would be more than enough supply to meet the potential growth in demand. Additionally, it also means that KDCR has some freedom to refresh its colocation clients in the years to come.

Lastly, on the sustainability front, KDCR is also not standing still. Already all of the colocation data centres in Singapore attained green certifications for efficient energy and water management. Moving forth, KDCR’s management is also looking into renewable energy sources to power its data centres.

Ratings

Having shared what I liked and my concerns about KDCR, I will now provide my personal rating of KDCR as an investment. As always, I will base my ratings on growth, stability and valuation.

Growth

Rating: 4 out of 5.

In terms of growth. I give KDCR a 4/5 star rating. This is due to the expected growth of the global data centre industry in the coming years.

Furthermore, KDCR also has sufficient debt headroom to build upon its forays into the European data centre market. With the backing of its sponsor, I feel that the growth prospects of KDCR will remain strong in the coming years.

The reason for me not giving it a full 5-star rating is ultimately down to the growth prospects of the Singapore data centre market, where the majority of KDCR’s income still originates from.

But hey a 4 star rating is still great!

Stability

Rating: 5 out of 5.

Stability-wise, there is nothing more that you can ask of KDCR.

With a relatively long WALE for its portfolio, there won’t be much disruption to the earnings of KDCR. Furthermore, data centres are also poised to increase in prominence in the coming years. All these thus provides a steady stream of income for KDCR in the years to come.

While a sizeable portion of overall rental income is tied to lease renewals in the next 2 years, I do not expect too many issues with either renewing the leases or sourcing for potential clients.

On that note, I thus gave a full 5 star rating to KDCR’s earnings stability.

Valuation

Rating: 2 out of 5.

Given KDCR’s current market price, I feel a 2-star rating for valuation is appropriate. Personally, I think that KDCR is currently overvalued based upon its PB ratio, AFFO yield and capitalisation rate.

Price-to-book ratio

At a market price of $2.69, KDCR’s PB ratio stands at 2.26. This value is way higher than KDCR’s average 5 year PB ratio.

Based on KDCR’s average 5-year PB ratio, a fair market price would be around $2.02. This represents a 24.9% decrease from the current price.

If we were to factor in a 5% growth rate in KDCR’s NAV, a fair market price (based upon the average 5 year PB ratio) would be around $2.12.

Either way, the current market price of KDCR can thus be said to be rather overvalued, based solely on PB ratio.

AFFO yield

With KDCR’s current market price, its AFFO yield comes in at around 3.63%.

Comparing this figure to the average market cap rate of 7.5% for data centres, KDCR’s current price is considered to be overvalued.

However, given the wide disparity in AFFO yield and market cap rate it does not make sense to use the AFFO yield as a valuation metric. Hence, I decided to use the current market cap rate for KDCR as a comparison to the average market cap rate of 7.5% instead.

Capitalisation rate

Using the average cap rate of 7.5% for data centres and KDCR’s net operating income for FY2020, KDCR’s fair valuation comes in at around S$3.255 billion.

Compared to KDCR’s current market capitalisation of S$4.393 billion, the share price of KDCR can be considered to be overvalued.

For KDCR’s market cap to be at its fair valuation, the share price of KDCR should be at $1.99.

Putting all three valuation metrics together, we can conclude that KDCR’s fair price is around $2. Given that the current market price represents a 34.5% premium, I thus gave a 2-star rating for the valuation of KDCR.

Final rating and conclusion

Rating: 3.5 out of 5.

Putting all the ratings together, KDCR thus have a final rating of 3.5/5 stars.

Overall, I feel that KDCR is a solid REIT to invest in. While its growth prospects in the local scene might be subdued, there should be an abundance of overseas opportunities given the global growth of the data centre market.

Furthermore, a solid financial position also enables KDCR to position itself nicely for future acquisitions. Whether such acquisitions would be DPU and NAV accreditive remains to be seen. However, I do have high hopes with how KDCR’s DPU and NAV have been over the past years.

Nevertheless, I feel that now is not the right time to invest in KDCR given its rather high market valuation. Potential investors might want to wait for the next market correction before investing, so as to have a greater margin of safety.

Do you agree with my assessment of Keppel DC REIT? Let me know in the comments I would love to see some of your thoughts!

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17 Comments

  1. Very good and detailed write up.
    Are your FFO and AFFO formula as below as per Investopedia ?
    FFO = net income + amortization + depreciation – capital gains from property sales
    AFFO = FFO + rent increases – capital expenditures – routine maintenance amounts

    Do you mind to share how you get the “rent increases” and “routine maintenance amounts” ?

    1. Hmm, a little different.

      For my AFFO I based it off the cash flow statement, so
      AFFO = Cash generated from operations before working capital – interest paid – Capex – tax paid

      The Capex portion is on the grey side coz KDCR does not really reveal what the recurring Capex is and what it is being spent on.
      But I still include the full Capex expense as Capex is not done without reason.

      For routine maintenance costs, KDCR already includes them in the property operating expenses portion of the statement of profit or loss. So net income would have already factored those in.

      1. So your AFFO is similar to FCF. Also similar to distributable income but without considered fees taken in units. For the capex, most REITs only disclose detail breakdown in Annual Report instead of quarter report, make it quite difficult to calculate AFFO or FCF if AEI/Construction is involved.

        Looking forward to your next post.

        1. Yup in a sense yes AFFO is similar to FCF.

          However, I feel AFFO differs from distributable income as AFFO looks at the net recurring cash from the REIT’s operations.
          While distributable income includes expenses and income which may not be derived from a REIT’s day to day operations.

          I think moving forth AFFO will be tougher to calculate as REITs sometimes lump Capex and construction costs in their cash flow statement in annual reports.

          Lastly, thanks for the encouragement!

          1. There is no standardize formula for AFFO as mentioned in investopedia, only FFO is standardize and show in US REIT report. You can tune it to have apple to apple comparison with REITs. I simply use distribution divided by gross revenue to check on distribution margin. To see whether management able to manage expenses effectively.

            Good post must share, I’ve again shared in my Facebook group – REIT Investing Community again. Hopefully can bring some traffic to u.

  2. Very comprehensive and good charts helps me quickly absorbs lots of financial details on the go.Appreciate your hard work ,well done.

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