On 24 July 2023, Keppel DC REIT (“KDC”) have announced their 2023 half year result. We are starting to see the effects of the current environment on the fundamentals of KDC, where their recent refinancing has caused cost of borrowings to increase and DPU have remained unchanged this half of the year despite the increase in net property income.
This is not unexpected given that other REITs in the market are also facing similar challenges. However, KDC is trading at a significant premium due to their data centre exposure, which will also mean higher potential capital loss should there be any black swan event. This industry 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. Investors should take note of their risk appetite and assess accordingly.
Website: Financial Statements And Related Announcement::Half Yearly Results
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% |
DPU for the first half of 2023 have remained unchanged at SGD0.0505 when compared with the same period in the previous financial year. While net property income have increased, finance costs have increased substantially as well resulting in an overall decrease in profit after tax. Distributable income was able to remain unchanged due to the net tax and other adjustments. This metric is Unfavorable.
Occupancy
| Metrics | Current | Previous |
|---|---|---|
| Occupancy | 98.5% | 98.5% |
Occupancy rate as at 30 June 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 | 36.3% | 36.8% |
Gearing ratio stands at 36.3% as at 30 June 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 | 6.0x | 6.8x |
The interest coverage stands at 6.0 times as at 30 June 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 25 August 2023 have announced that they may need to raise interest rates further to cool the still-too-high inflation, despite having increased the interest rates to a range between 5.00% and 5.25% on 26 July 2023, the highest level in 22 years.
Website: Fed’s Powell: higher rates may be needed, will move ‘carefully’
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 30 June 2023:
| Description | Amount (SGD’000) |
|---|---|
| Total Debt | $1,400,000 |
| Debt Not Hedged (%) | 27.0% |
| Debt at Floating Rate Exposed | $378,000 |
| 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 | -$1,890 | -1.0% |
| + 100 bps | -$3,780 | -2.0% |
| + 150 bps | -$5,670 | -3.1% |
| + 200 bps | -$7,560 | -4.1% |
| + 250 bps | -$9,450 | -5.1% |
| + 300 bps | -$11,340 | -6.1% |
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 | 3.9 years | 3.8 years |
Weighted average term to maturity of their debt stands at 3.9 years as at 30 June 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 | 1.58 | 1.50 |
The Price to Book (“P/B”) ratio currently stands at 1.58. This is computed using the closing share price of SGD2.20 on 15 September 2023 and the net asset value per share of SGD1.39 as at 30 June 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 | 4.64% | SGD 0.102 |
| 2022 | 3.89% | SGD 0.086 |
| 2021 | 5.06% | SGD 0.111 |
| 2020 | 2.88% | SGD 0.063 |
| 2019 | 4.25% | SGD 0.094 |
| 2018 | 3.23% | SGD 0.071 |
At 15 September 2023, with a closing share price of SGD2.20 and dividend payout of SGD0.102 for the full calendar year 2023, this translates to a dividend yield of 4.64%. 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 2023Q3
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 15.7% to SGD1.85. Investors will thus need to be mentally prepared that the share price might further fall.
| Yield | Share Price | Downside |
|---|---|---|
| Current (4.64%) | 2.20 | – |
| 5.50% | 1.85 | -15.7% |
| 6.50% | 1.57 | -28.7% |
| 7.50% | 1.36 | -38.2% |
| 8.50% | 1.20 | -45.5% |
This is important to note as interest rate for long-term safe assets is on an uptrend for the last few months. The latest upcoming October 2023 Singapore Savings Bond is being issued with a 10-year average interest rate of 3.16%. There is a chance for interest rates to continue to increase moving forward, and the required dividend yield of investor may be higher than current. This may cause further share price depreciation for the dividend yield to compensate for the risk appetite of investors.
Website: SBOCT23 GX23100T Bond Details
The dividend yield is Unfavorable.
Key things to note
Tenant profile
KDC have a high tenant concentrations where the top 10 tenants contributing to 78.6% of their total gross rent with the top tenant accounting for 35.2% for the month of June 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 | – | Unfavorable |
| Occupancy | 98.5% | Favorable |
| Gearing Ratio | 36.3% | Favorable |
| Interest Coverage | 6.0x | Favorable |
| Debt Maturity Profile | 3.9 years | Favorable |
| Price to Book Ratio | 1.58 | Unfavorable |
| Overall | | Favorable |
Overall, the metrics indicate that it is still favorable to invest in KDC. Despite the current economic conditions, the fundamentals of KDC have remained stable and is a resilient passive income generator. However, investors will still need to assess their risk appetite given the high tenant concentration and low dividend yield.
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): 2023 First Quarter Business Update
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