On 26 October 2022, Keppel DC REIT (“KDC”) have announced their 2022 third quarter business updates. For a business update, they have provided quite a lot of information to be almost a full update. Their results can be seen to continue remaining stable. However they are still trading at a significant premium due to their data centre exposure, resulting in a lower dividend yield.
Background
KDC was listed on the Singapore Exchange on 12 December 2014 as the first pure-play data centre REIT in Asia.
KDC’s investment strategy is to principally invest, directly or indirectly, in a diversified portfolio of income-producing real estate assets which are used primarily for data centre purposes, as well as real estate and assets necessary to support the digital economy.
KDC’s investments comprise an optimal mix of colocation, fully-fitted and shell and core assets, as well as network assets through its investments in debt securities, thereby reinforcing the diversity and resiliency of its portfolio.
KDC is sponsored by Keppel Telecommunications & Transportation Ltd (“Keppel T&T”), a wholly-owned subsidiary of Keppel Corporation Limited. It is managed by Keppel DC REIT Management Pte. Ltd. (the “Manager”)., a wholly-owned subsidiary of Keppel Capital Holdings Pte. Ltd. (“Keppel Capital”). Keppel Capital is a premier asset manager in Asia with a diversified portfolio in real estate, infrastructure, data centres and alternative assets in key global markets through its listed REITs and Trust, as well as private funds.
The Keppel Group, through Keppel T&T and the private data centre funds has currently over SGD2 billion worth of data centre assets under development.
Key Metrics
Distribution Per Unit (“DPU”)
Based on the announcement on 26 October 2022, it was noted that DPU for the 9 months ending 2022Q3 have increased by 3.4% to SGD0.0763 from SGD0.0738 in the 9 months ending 2021Q3. It is worth noting that the DPU increase was from higher finance income mainly due to interest income from NetCo Bonds and coupon income from Guangdong Data Centre 3. Although this is not directly related to their properties, the income is recurring and provides stable income for KDC.
This metric is Favorable.
Occupancy
Occupancy rate as at 30 September 2022 stands at 98.6%. This is Favorable as it is above my expected healthy occupancy rate of 95% and KDC have been able to maximize utilizing their assets.
Gearing ratio
Gearing ratio stands at 37.5% as at 30 September 2022. This to me is Favorable, as it is still a distance away from the MAS limit of 50% and with the long debt maturity profile, gives them opportunities to fund new acquisitions through debt.
Interest coverage
The interest coverage stands at 8.5 times as at 30 September 2022. The metric is Favorable as the interest coverage is higher than my preference of 5.0 times. They are well positioned to handle any further interest rate increases as the world looks to tackle inflation. The Federal Reserve on 14th December 2022 has hiked interest rates by another 0.5% to 4.5%, the highest level in 15 years, and is looking to to keep rates higher through next year with no reductions until 2024.
Website: Fed raises interest rates half a point to highest level in 15 years
As the interest rate may potentially increase further, KDC may be subjected to significant change in their cost of debt in the near future. In their presentation they have mentioned that 74% of their debt is also on fixed rates.
I have thus performed a sensitivity analysis using the information as at 30 September 2022:
Interest rate sensitivity analysis as below:
Do note the above is my estimation which may be different from management’s estimation. Nonetheless, if the interest rates were to increase by the basis points above, KDC may experience a fall in DPU accordingly. Their higher sensitivity is due to a significant portion of their debts are not hedged as compared to other REITs.
Debt maturity profile
Weighted average term to maturity of their debt stands at 3.9 years as at 30 September 2022. This is Favorable and it allows them sufficient time to refinance their debts as they fall due.
Price to Book Ratio
Based on 30 September 2022 figures, the Price to Book (“P/B”) ratio currently stands at 1.37. This is computed using the closing share price of SGD1.84 on 14 December 2022 and the net asset value per share of SGD1.34 as at 30 September 2022. KDC still command a premium due to their data centre exposure. However, in the current macro-economic environment, there are REITs that are trading close or below book value. There is potential that if the results become significantly more unfavorable, they may experience a larger decrease in price.
The metric is Unfavorable as investors are paying a significant premium although this is a REIT with a strong sponsor.
Dividend yield
At 14 December 2022, with a closing share price of SGD1.84 and dividend payout of SGD0.086 for the full calendar year 2022, this translates to a dividend yield of 4.65%. For my REIT’s benchmark, a general reasonable range would be around an average of 6.0% to 7.0% in the current environment. KDC’s dividend yield is below my benchmark.
Furthermore, interest rates have been continuously increasing the last few months. This have prompted for multiple safer assets to increase their bond and interest rates to more than 3%, causing the previous yields of KDC to become unfavorable.
Website: Reasonable Dividend Yield Changes
If using dividend yield of 6% as a benchmark, based on the dividend of SGD0.086 there is potential for KDC to see its share price drop by another 22.1% to SGD1.43. Investors will thus need to be mentally prepared that the share price might further fall if interest rates for safe assets in Singapore looks to cross and stabilize above 4%.
The dividend yield is Unfavorable.
Key things to note
Tenant profile
KDC have a high tenant concentrations where the top 10 tenants contributing to 79.1% of their total gross rent with the top tenant accounting for 36.0% for the month of September 2022. This is risky as KDC is heavily reliant on their tenants for income. The withdrawal of any tenant will have a significant impact on their DPU. Furthermore their tenant profile tend to be in the technology industry, which is facing severe cost pressures in the current high interest rate environment.
Website: These Are the Tech Companies Slashing Jobs in an Uncertain Economy
Summary
Overall, the metrics indicate that it is favorable to invest in KDC. Despite the drop in share price over the last few months, the fundamentals of KDC did not worsen during this quarter. This suggests that the current share price is due to overall market sentiment. It is possible for the share price to recover should interest rates decrease over the next few years.
The recent market conditions present opportunities for entry as the share price continues to face downward pressure. However KDC has a lower dividend yield and a high tenant concentration compared to other REITs. Investors need to take note of their own risk profile and deem if it is worth the risk, especially as safe assets have seen their yield rise considerably with rising interest rates.
Disclaimer: Not financial advice. All data and information provided on this site is for informational purposes only.
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