If you are looking for a steady growing dividend (and the potential for continuing long-term share price appreciation) the data center REIT we review in this report is attractive. For starters, it has raised its dividend (current yield is 2.9%) for 16 straight years (since its IPO) thanks to steady growth in its funds from operations (~11% CAGR since 2005). And even though core FFO per share declined in 2020 (pandemic year) it is on pace to bounce back in 2021. Further, it will continue to benefit from the massive ongoing secular digital transformation. In this report, we review the business, valuation, dividend safety, risks and then conclude with our opinion on investing.

Overview:

Digital Realty Trust (DLR) is in the business of owning, acquiring, developing and operating data centers. If you don’t know, a data center is basically “the cloud.” Specifically, it’s a collection of servers used by individuals and organizations to store their information offsite. Digital Realty’s data centers are wide ranging and sophisticated, including colocation sites to enterprises and hyperscale data facilities.

Digital Realty’s portfolio consists of 291 data centers, including 44 data centers held as investments in unconsolidated joint ventures. Of these, 142 are located in the North America, 104 in Europe, 23 in Latin America, 12 in Asia, six in Australia and three in Africa.

DLR is well diversified geographically. North America is its largest market accounting for approximately 62% of its total operating revenue as of 2Q21. This is followed by EMEA at nearly 29%, APAC at 7% and Latin America at 2%.

Moreover, DLR boasts of high quality and diversified customer base across industries ranging from cloud and information technology services to communications and social networking to financial services, manufacturing, energy, gaming, life sciences and consumer products. The top 20 customers account for just 48.8% of total rent with no single customer accounting for more than 9.5% of rent. More than 50% of its clients have investment grade or equivalent credit ratings.

Digital Realty continues to expand its global presence, thereby positioning itself well for future growth. For example, during Q2, DLR opened its third data center in Singapore, a 50 megawatt facility. It also plans to open several new facilities in Asia including in Tokyo, Osaka and Seoul. In addition, it is targeting to enter the Indian market in partnership with Brookfield Infrastructure.

We are also impressed by DLR’s sustainable growth initiatives. For example, all of Digital Realty's European properties (as well as its US colocation business) are powered 100% by renewable energy. And overall, half of Digital Realty's global portfolio is now powered by renewables, up from 30% in 2019. And with ESG-focused investing becoming the standard, DLR is likely to receive more meaningful investor attention.

Healthy Tenant Base: Digital Realty’s tenant retention rate has recently been slightly above its historical average of ~80%. Further, the company expects its occupancy rate to be between 84-85% for 2021. The metrics bode well for income and cash flow visibility. Moreover, nearly 93% of the company’s leases contain base rent escalations that are either fixed (generally ranging from 2% to 4%) or indexed based on a consumer price index. This provides for rental income growth which allows DLR to support a healthy growing dividend payout to investors.

Furthermore, Digital Realty delivered solid bookings during the second quarter of this year (driven by the ongoing and accelerated global digital transformation). For example, total bookings signed during 2Q21 are expected to generate $113 million of annualized GAAP rental revenue, including a $13 million contribution from interconnection as well as $41 million network & enterprise deals of 1MW or less.

Also worth mentioning, DLR experienced strong demand across all three regions in 2Q, with APAC and EMEA accounting for 20% each, respectively, Americas contributed nearly 50% and interconnection was responsible for a little over 10%. We believe the strong diversification of bookings highlights the strong value proposition offered by DLR.

Healthy Cash Position, Healthy Dividends

Digital Realty has increased its dividend for 16 consecutive years, growing the payout from $1.00 in 2005 to an estimated $4.64 in 2021. This represents a CAGR of ~10% (from 2005 - 2021E). Further, we’re impressed (but not surprised) by the company’s ~3.5% dividend increase this year. And based on the 2021 consensus core FFO estimate, the payout ratio will be ~72% this year.

Also important, ~90% of DLRs debt is based on a fixed rate (to help guard against rising rates), and 98% of the debt is unsecure (providing flexibility for capital recycling). Further, DLR has no debt maturing until 2021 (which provides it with ample cash flow to not only pay its dividend but continue to raise it over time). We expect ongoing and meaningful future dividend increases over time.

Exposed to Long-Term Secular Demand Drivers

The digital transformation and the Internet of Things (IoT) has led to an explosive growth in data with no end in sight. Further, to support this data, organizations and individuals are increasingly moving to the cloud. This is a long-term secular trend that is still only in its early innings—which means Digital Realty continues to have a lot more room for long-term growth.

Digital Realty’s primary focus is on hybrid cloud solutions. This allows companies to store their sensitive information on private cloud servers, while using public cloud-based applications to reduce IT costs. Hybrid cloud is the largest part of the industry (~69% of companies use hybrid cloud solutions). Hybrid cloud models ae executed using multi-tenant data centers, such as the ones provided by Digital Realty.

The Internet of Things, 5G, autonomous vehicles and artificial intelligence are just some of the trends that are driving unprecedented growth and demand for data centers—to the benefit of Digital Realty.

Valuation:

On a price-to-Adjusted-Funds-from-Operations (“P/AFFO”) basis, DLR is reasonably attractive relative to its peer group. For example, DLR’s P/AFFO is slightly below the peer group average and lower than the majority of its peers. However, DLR has a healthy EBITDA margin, a conservative payout ratio and expects mid-single digit earnings growth in 2021. And given the well-run blue-chip nature of the business, we view DLR shares as attractive for long-term dividend-growth investors.

DLR Share Price:

Risks:

Technology disruption: The current market environment is favorable for data center operators as enterprise and IT customers continue to outsource and decentralize their IT operations. We acknowledge that this could reverse (although unlikely), pushing companies back to sourcing their own requirements internally, thereby decreasing demand for data center space.

Reliable Infrastructure: The business depends on providing customers with highly reliable services, including with respect to power supply, physical security and maintenance of environmental conditions. If these infrastructure components break or are rendered obsolete, it may lead to a loss of customers thereby adversely impacting earnings.

Competition: DLR competes with numerous data center providers, many of whom own properties similar to DLR in the same metropolitan areas. Some competitors and potential competitors have significant advantages, including greater name recognition, longer operating histories, pre-existing relationships with current or potential customers, significantly greater financial, marketing and other resources and more ready access to capital. In addition, many competitors have developed and continue to develop additional data center space. If the supply of data center space continues to increase as a result of these activities or otherwise, rental rates may be reduced which will negatively impact operating results.

Conclusion:

Digital Realty is an attractive data center REIT with a growing dividend and ongoing share price appreciation potential as the ongoing digital transformation continues to increase demand for cloud-based data solutions (and DLR has carved out a very attractive niche for itself in this space). The dividend yield of 2.9% is not huge (but it’s double the S&P 500 yield and growing faster), and the valuation is not extreme (DLR’s valuation is quite reasonable for long-term dividend growth investors). For these reasons, we rank DLR as one of our top long-term dividend growth stocks and we continue to own shares.

You can view all of our current holdings here.

Data Center REIT: Growing Dividend to Benefit from Ongoing Digital Transformation