Digital Realty Trust: Is This 3.5%-Yielding Data Center REIT A Buy?
Summary
- Digital Realty Trust is a fast-growing data center real estate investment trust with a first-class client base.
- The REIT has grown its funds from operations and dividend very quickly in the last decade.
- Digital Realty Trust's shares are not cheap, and an investment in DLR yields 3.5 percent.
- The yield on cost is most likely going to rise going forward.
Digital Realty Trust, Inc. (NYSE:DLR) makes a decent value proposition for income investors that are comfortable with paying an elevated FFO multiple for the chance of capturing above-average dividend growth going forward. Digital Realty Trust has seen very strong FFO/share growth over the last decade thanks to growing demand for data centers. Digital Realty Trust covers its dividend with funds from operations and has significant room left to grow its payout. Shares are highly valued, and throw off an entry yield of 3.5 percent.
Digital Realty Trust - Company Overview
Digital Realty Trust provides data centers to large enterprise customers, largely tech firms and banks. Digital Realty Trust's real estate portfolio consists of 214 data centers, reflecting more than 34 million square feet. The REIT's properties are spread out all over the United States, but are nonetheless concentrated in major urban areas with attractive economic fundamentals.
Source: Digital Realty Trust Investor Presentation
Digital Realty Trust is a U.S.-anchored data center REIT with global ambitions. The REIT's data centers can also be found in Europe, Australia and Brazil. The majority of the REIT's annualized base rent (80 percent), however, still comes from the United States.
Source: Digital Realty Trust
Digital Realty Trust's customers include the largest and fastest-growing technology companies in the world, including Facebook (FB), IBM (IBM), Oracle (ORCL), and Uber (UBER).
Source: Digital Realty Trust
Growing internet use and traffic volumes point to growing demand for data centers in the future. As users create and consume more computing-intensive (video) content, companies that provide data centers face attractive long-term demand dynamics.
Source: Digital Realty Trust
Digital Realty Trust faces attractive growth dynamics in more than just one industry, though. Machine learning, autonomous driving, augmented and virtual reality, and the Internet of Things are projected to grow drastically until 2025, and likely beyond. Strong projected growth in these industries imply growing demand for data center and cloud solutions, the kind Digital Realty Trust provides.
Source: Digital Realty Trust
Strong and growing demand for data center and cloud solutions has already translated into above-average FFO/share growth for Digital Realty Trust. The REIT increased its funds from operations by 11.4 percent annually from 2006 to 2019 (based on guidance). Digital Realty Trust also widely outperformed its peers in the sector.
Source: Digital Realty Trust
Distribution Coverage And Growth
Digital Realty Trust widely outearns its dividend with both core funds from operations and adjusted funds from operations.
In the last twelve quarters, Digital Realty Trust earned $1.54/share in core FFO and $1.40/share in adjusted FFO, on average. This compares favorably to an average quarterly dividend payout of $0.94/share.
Here are Digital Realty Trust's updated dividend coverage stats.
Source: Achilles Research
And here's Digital Realty Trust's AFFO payout ratio (average: 67 percent).
Source: Achilles Research
Besides a very conservative AFFO payout ratio, Digital Realty Trust is growing its dividend fast, which points to a growing yield on cost over time. Digital Realty Trust has quadrupled its dividend from $1.00/share in 2005 to $4.04/share in 2018.
Source: Digital Realty Trust
Valuation
Digital Realty Trust has guided for its core funds from operations in 2019 to fall into a range of $6.60-$6.70/share. Since shares today sell for $122.41/share, the REIT's valuation effectively implies a 18.4x 2019e core FFO multiple. The high FFO multiple reflects investor expectations that the REIT will be able to capture above-average FFO growth in the future and that it will be able to deliver above-average dividend growth as well.
Risk Factors Investors Need To Consider
Digital Realty Trust operates in an industry with well-capitalized clients and strong growth trends. Even in the event of an economic downturn, data center REITs should do well as users will continue to create and consume content, and new technologies such as virtual reality and artificial intelligence will require more computing power going forward. However, slowing FFO/share growth over time could be a concern and is something investors have to consider as a risk factor. As the REIT's FFO/share growth slows, I expect the REIT to trade at a lower FFO multiple.
Your Takeaway
Digital Realty Trust is right where the growth is. Key industry trends point to growing demand for computing power which helps make the case for an investment in a diversified data center REIT. Digital Realty Trust has produced above-average FFO/share growth in the last thirteen years, easily outearns its dividend and actually has a very conservative AFFO payout ratio. Further, the REIT is growing its dividend very fast. Digital Realty Trust has a high FFO multiple that reflects elevated investor expectations so I would limit the size of an investment in DLR to 2-3 percent of portfolio assets, max. Only buy Digital Realty Trust if you are comfortable with paying 18x 2019e core FFO for the REIT's dividend stream.
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