Keppel DC REIT (SGX: AJBU) is Singapore’s first pure Data Centre REIT, which is known to be quite resilient. Nonetheless, due to higher interest rates, all REITs are badly affected by the higher cost of debt, and Keppel DC REIT (KDC) is not excluded. Many investors have avoided KDC due to its rich valuations but could this be a mistake? Let’s take a deep dive into the 5 important takeaways from Keppel DC REIT FY2023 results.
1. Unforeseen Impacts to Gross Revenue and NPI
| Year on Year Difference | FY2023 | FY2022 |
|---|---|---|
| Gross Revenue | S$281.207 million (+1.4%) | S$277.322 million |
| Net Property Income (NPI) | S$244.951 million (-3.0%) | S$252.545 million |
Jumping right into the results, Keppel DC REIT has posted a relatively flat set of earnings with Gross Revenue growing by only 1.4% year over year. It’s interesting to note that the NPI is down by 3% due to much higher property expenses, specifically from loss allowance accounted for the uncollected rental income from the Guangdong DCs, which have yet to pay until now. The total amount due is approximately S$17.6m (not including late payment interests and real estate taxes). If this amount was paid to KDC, the NPI would actually be positive, increasing by 3.96%.
2. Weak Distributable Income and DPU
| Year on Year Difference | FY2023 | FY2022 |
|---|---|---|
| Distributable Income | S$167.718 million (-9.3%) | S$184.872 million |
| Distribution Per Unit (DPU) | 9.383 cents (-8.1%) | 10.214 cents |
KDC saw a huge increase in its finance cost, growing by S$17.446m (56.1%). This ultimately resulted in a net decrease in Distributable Income and DPU by 9.3% and 8.1% respectively. For more context on how bad the high interest rates are impacting KDC, if the finance cost were to stay flat in comparison to last year, the distributable income would actually be slightly net positive (S$0.292m). It’s also good to note that due to the loss allowance related to uncollected rental and coupon income of ~5.5 months at the Guangdong DC, this impacted KDC’s overall DPU by 0.649 cents
3. Balance Sheet Holding Steady
| As at 31 December 2023 | As at 31 December 2022 | |
|---|---|---|
| Aggregate Leverage | 37.4% | 36.4% |
| Interest Coverage | 4.7x | 7.6x |
| Average Cost of Debt | 3.3% | 2.2% |
Moving onto the financials, we can see that the aggregate leverage has increased slightly from 36.4% to 37.4%. The current aggregate leverage is at a manageable level because, with the current high interest rate environment, accretive acquisitions will be scarce. It will be more meaningful for the management to lower their debt during this time.
As we can see from the table above, the average cost of debt has grown a lot from 2.2% to 3.3% year over year. KDC has also increased its % of fixed debt slightly to 74%. This means that due to the remaining 26% unhedged borrowings, a 100bps increase would result in a ~2.6% impact on 2H 2023’s DPU on a pro forma basis. As the market is forecasting several cuts this year, we might see a net increase in DPU instead.
The overall trailing 12-month Interest Coverage Ratio (ICR) has also decreased from 7.6x to 4.7x, which is still quite manageable as it is higher than 3x. The reason why I use 3x as a benchmark is because MAS proposed a new requirement for all Singapore REITs in Jan 2022, which states that S-REITs need to have a minimum of 2.5x ICR before they are allowed to leverage beyond the prevailing 45% limit (up to 50%). Allowing for some headroom, 3x ICR is a good benchmark to gauge if a REIT has sufficient room and flexibility to leverage higher for possible acquisitions.
4. Portfolio Stability
Looking at Keppel DC REIT’s portfolio, we can see that it is very resilient and stable with a strong portfolio occupancy of 98.3% and a long WALE of 7.6 years. The portfolio is very diversified across different contract types with a well-spread expiry profile. Based on rental income, we can see that 27.5% are expiring in 2024 and 22.9% are expiring in 2025, which means a little more than 50% of the leases are expiring over the next 24 months. KDC did mention new and renewal contracts were secured but did not disclose if they were referring to the expiring leases in 2024 and 2025.
Following up regarding 2 tenants with issues recently, KDC is currently in dispute with DXC, whereby the court judgement has already passed in favor of KDC and we should expect some sort of settlement after the trial in February 2024. Regarding the Guangdong DCs, the tenant has settled part of the sums in arrears of RMB 0.5m (S$0.1m). The tenant will be working closely with KDC to slowly pay back the remaining sum owed.
5. Growth Potential
Seeing how KDC has performed poorly this year, is there any room for long-term growth? Let’s take a look at possible growth opportunities for Keppel DC REIT.
Acquisition Opportunities from Sponsor
Keppel DC REIT is fortunate to have a large sponsor (Keppel) which has over S$2B in potential DC assets for acquisition. These DC assets are currently under Keppel as well as Keppel’s private DC funds, and span across a few key countries such as Singapore, Australia, China, Indonesia, and The Netherlands.
KDC’s maiden acquisition into the China market was in 1H 2021, right after releasing its 1H 2021 results. The strategic acquisition of Guangdong Data Centre in Jiangmen, Guangdong Province, proves to be a fantastic acquisition with a triple net lease for 15 years and the acquisition price representing a 7.8% discount to the independent market valuation. Given the right circumstances, I believe KDC can venture deeper into the China market should suitable opportunities arise.
Final Thoughts
Despite its resilient nature, Keppel DC REIT has also fallen victim to the high interest rate environment. Nonetheless, I believe that these issues are only temporary and KDC will slowly adapt to the current situation. Looking at KDC organically, if we were to set aside the higher cost of debt and issues regarding the 2 tenants, KDC did well this year with low single-digit growth.
Upon market opening, we can see that the market is definitely not happy with KDC’s results, with the share price falling by ~2% to $1.76. At this price, the TTM yield stands at 5.33% which is really attractive as it’s above the 5-year average and the PB ratio is standing at a reasonable 1.3x.