On 18 April 2023, Keppel DC REIT (“KDC”) have announced their 2023 first quarter business update. The overall metrics is in the favorable range given that their financial position remained relatively stable this quarter. Their expected dividend yield of close to 5.00% is also not undesirable given that long-term interest rates have continued to fall over the last few months.
The recent happenings with Digital Core REIT (SGX: DCRU) and one of their largest customer is something we should take note of for KDC and their top tenant. Although there are no expected issues in the near future, the nature for most of the retail investors is that usually we may only be updated of any business happenings in the news or when the company decide to halt the trading of their share price. By that time, usually it is already considered too late even if we are subscribed to the newsletter. Investors should therefore pre-emptively take note of their risk profile and assess the individual comfort levels and exposure.
KDC is trading at a significant premium due to their data centre exposure, resulting in a lower dividend yield compared to some of its peers. This industry however in my opinion will be one that remain more resilient and low supply in the short term, especially as the world continues to be more technologically integrated and there is continued demand for data.
Photo source: https://www.keppeldatacentres.com/locations/asia-pacific/singapore/dc-1/
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.
Key Metrics
Distribution Per Unit (“DPU”)
| Metrics | Current | Previous |
|---|---|---|
| Distribution Per Unit | +3.0% | +3.7% |
DPU for the first quarter of 2023 have increased by 3.0% to SGD0.02541 from SGD0.02466 from the same quarter in the previous financial year. While revenue have increased, so has property expenses and it is worth noting that the DPU increase was mainly from higher finance income 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
| Metrics | Current | Previous |
|---|---|---|
| Occupancy | 98.5% | 98.5% |
Occupancy rate as at 31 March 2023 remained unchanged at 98.5%. 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
| Metrics | Current | Previous |
|---|---|---|
| Gearing Ratio | 36.8% | 36.4% |
Gearing ratio stands at 36.8% as at 31 March 2023 and is relatively unchanged from the previous quarter as well. 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
| Metrics | Current | Previous |
|---|---|---|
| Interest Coverage | 6.8x | 7.6x |
The interest coverage stands at 6.8 times as at 31 March 2023. 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 should banks increase their interest rates for their borrowings. The Federal Reserve on 3 May 2023 has hiked the interest rates to a range between 5.00% and 5.25%, the highest level in 15 years and are likely to keep it at these levels over the next few years.
Website: US Fed raises interest rates again, signals potential pause in tightening cycle
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 73% of their debt is also on fixed rates.
I have thus performed a sensitivity analysis using the information as at 31 March 2023:
| Description | Amount (SGD’000) |
|---|---|
| Total Debt | $1,500,000 |
| Debt Not Hedged (%) | 27.0% |
| Debt at Floating Rate Exposed | $405,000 |
| Distributable Income FY2022 | $184,872 |
Interest rate sensitivity analysis as below:
| Change in Interest Rates | Decrease in Distributable Income (SGD’000) | Change as % of FY2022 Distribution |
|---|---|---|
| + 50 bps | -$2,025 | -1.1% |
| + 100 bps | -$4,050 | -2.2% |
| + 150 bps | -$6,075 | -3.3% |
| + 200 bps | -$8,100 | -4.4% |
| + 250 bps | -$10,125 | -5.5% |
| + 300 bps | -$12,150 | -6.6% |
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
| Metrics | Current | Previous |
|---|---|---|
| Debt Maturity Profile | 3.8 years | 3.7 years |
Weighted average term to maturity of their debt stands at 3.8 years as at 31 March 2023. This is Favorable and it allows them sufficient time to refinance their debts as they fall due.
Price to Book Ratio
| Metrics | Current | Previous |
|---|---|---|
| Price to Book Ratio | 1.50 | 1.37 |
The Price to Book (“P/B”) ratio currently stands at 1.50. This is computed using the closing share price of SGD2.05 on 16 June 2023 and the net asset value per share of SGD1.37 as at 31 March 2023. 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
| Year | Yield | Total |
|---|---|---|
| 2023 | 2.52% | SGD 0.052 |
| 2022 | 4.17% | SGD 0.086 |
| 2021 | 5.43% | SGD 0.111 |
| 2020 | 3.09% | SGD 0.063 |
| 2019 | 4.57% | SGD 0.094 |
| 2018 | 3.47% | SGD 0.071 |
My current expected dividend payout remain unchanged from the previous quarter at SGD0.102 for calendar year 2023 using the dividend payout in August 2022 of SGD0.050 and February 2023 of SGD0.052 as a basis.
At 16 June 2023, with a closing share price of SGD2.05 and expected dividend payout of SGD0.102 for the full calendar year 2023, this translates to a dividend yield of 4.98%. For my benchmark, a general reasonable range would be around an average of 5.5% to 6.5% in the current environment. KDC’s dividend yield is below my benchmark.
Website: Reasonable Dividend Yield 2023Q2
If using dividend yield of 5.5% as a benchmark, based on the dividend of SGD0.102 there is potential for KDC to see its share price drop by another 9.5% to SGD1.85. Investors will thus need to be mentally prepared that the share price might further fall.
| Yield | Share Price | Downside |
|---|---|---|
| Current (4.98%) | 2.05 | – |
| 5.50% | 1.85 | -9.5% |
| 6.50% | 1.57 | -23.5% |
| 7.50% | 1.36 | -33.7% |
| 8.50% | 1.20 | -41.5% |
Nonetheless, it is worth noting that interest for long-term safe assets are on a downtrend. The July 2023 Singapore Savings Bond being issued with a 10-year average interest rate of 2.82%. There is a chance for interest rates may not increase significantly moving forward, and the required dividend yield of investor may be lower than current.
Website: SBJUL23 GX23070H Bond Details
The dividend yield is Neutral.
Key things to note
Tenant profile
KDC have a high tenant concentrations where the top 10 tenants contributing to 78.7% of their total gross rent with the top tenant accounting for 35.5% for the month of March 2023. 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.
Data centers are not directly affected as compared to office REITs, where a lower headcount translates to less office space needed. Data centers however are still a cost to the operations of the companies. Companies may therefore look for cheaper alternatives, which may in turn lower the overall outlook for KDC.
A recent example would be Digital Core REIT (SGX: DCRU), where their second-largest customer has declared bankruptcy in the US. Although there is expected to be minimal impact to Digital Core REIT given that current market conditions remain tight, their DPU could be halved as they are reliant on the customer. The same scenario may be applicable to KDC.
Website: Digital Core Reit manager warns DPU could be halved as second-largest tenant goes bust
Summary
| Metrics | Financials | Rating |
|---|---|---|
| Distribution Per Unit | +3.0% | Favorable |
| Occupancy | 98.5% | Favorable |
| Gearing Ratio | 36.8% | Favorable |
| Interest Coverage | 6.8x | Favorable |
| Debt Maturity Profile | 3.8 years | Favorable |
| Price to Book Ratio | 1.50 | Unfavorable |
| Overall | | Favorable |
Overall, the metrics indicate that it is favorable to invest in KDC. The fundamentals of KDC have continued to remain stable and is a resilient passive income generator.
Gentle reminder that with the ongoing economic conditions, there is a need to consider that 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.
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Disclaimer: Not financial advice. All data and information provided on this site is for informational purposes only.
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Website: Keppel DC REIT (SGX: AJBU): 2022 Full Year Result
