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Digital Realty: Almost Time to Buy

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GuruFocus.com
·8 min read
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- By Nathan Parsh

Shares of Digital Realty Trust Inc. (NYSE:DLR) have fallen more than 19% from the 52-week high, placing the stock on the doorstep of bear market territory. Digital Realty's results throughout last year were weaker in terms of funds from operation compared to the previous year, but not so much to warrant such a steep decline in a short period of time. In fact, the year-over-year declines were due to a much larger share count then any weakness in the trust's business.


Let's look at Digital Realty's most recent quarter and valuation to see why I find the stock more attractive as it declines.

Recent earnings results

Digital Realty reported fourth-quarter and full-year results on Feb. 11. The company produced revenue growth of 35% to $1.06 billion, which was $35.1 million ahead of Wall Street analysts' estimates. Much of the year-over-year growth was due to the acquisition of European cloud data center company Interxion that was completed on March 13, 2020. On a sequential basis, revenue improved 3.7%. Core funds from operations totaled $465 million, or $1.61 per share, compared to $355 million, or $1.62 per share, in the previous year. A 32% increase in the share count resulting from acquisitions was the reason behind the decline in funds from operations per share from the prior year. Funds from operations was 8 cents better than analysts had expected. The trust's portfolio occupancy rate improved 40 basis points to just over 90%, with all three regions showing at least 90% occupancy rates.

For 2020, revenue improved almost 22% to $3.9 billion. Core funds from operations totaled $1.7 billion, or $6.22 per share. This topped Digital Realty's guidance, but was a 6.5% decrease from the prior year. Once again, a higher share count was the culprit for the decrease.

While the Covid-19 pandemic presented a difficult operating environment for many companies, Digital Realty happens to operate in areas that were performing well. At 30%, cloud customers represent the single largest source of revenue for the trust. This business group saw immense demand for products as customers transitioned to the work and learn from home trend that occurred as a result of the pandemic. Other customers groups, such as Network (18% of revenue), Content (16%) and IT (14%), were also resilient in the face of the pandemic. Really, the only customers at risk from the impact of the pandemic were Retail, Energy and Travel/Lodging, but these three groups contribute just 4% of Digital Realty's revenue total.

Digital Realty had new bookings of $130.3 million in the fourth quarter, the trust's second-best quarterly booking amount after the second quarter's figure. The average term lease is over eight years and the trust attracted more than 120 new customers. As a result of new bookings, the company's backlog, including joint ventures, grew 17.5% to $254 million. For 2020, new bookings totaled nearly $443 million, which is a new record for the trust.

The trust also renewed $156 million worth of annualized GAAP rental income that were up 1% on a cash basis and higher by 3.4% on a GAAP basis during the fourth quarter. The weighted average lease was just over three years.

New bookings and lease renewals aren't the only way Digital Realty continues to grow. The trust closed on several acquisitions during the fourth quarter, including the purchase of Lamda Hellix, which is the largest independent data center and interconnection provider in Greece. In addition, Digital Realty's InterXion unit closed on its $217 million purchase of the Neckerman expansion in Frankfurt, Germany, which includes nine data centers with nearly nine years of remaining on the lease.

These two acquisitions will allow Digital Realty to expand its foothold in the Europe, Middle East and Africa region. For example, more than half of new clients in the fourth quarter came from the EMEA. The trust now has more than 88,000 cross-connections, 700 connectivity providers and 17 metro areas in Europe.

Digital Realty was very aggressive in adding to its existing business in 2020, with the trust nearly doubling how many countries that it operates in. As a result of this activity, more than half of new bookings in the most recent quarter were from outside of the Americas for the first time ever.

The company's balance sheet looks to be in good order. The trust had total assets of $36.1 billion at quarter's end, with current assets of $711.6 million and cash and equivalents of $108.5 million. Digital Realty does have $2.1 billion under its global revolving credit facilities as well.

Total liabilities stood at $17.6 billion, with current liabilities of $1.5 billion. Total debt was just over $15 billion, but just $532 million is due within the next year. Digital Realty retired $6.4 billion of debt last year, but also issued $7.2 billion of debt. Fortunately, debt maturities are rather spread out over the next decade or so. Weighted average maturity is 6.9 years and the weighted average coupon is just 2.3%. Interest expenses declined slightly to $333 million.

Digital Realty provided guidance for 2021. The trust expects revenue in a range of $4.25 billion to $4.35 billion, which would be a 10.3% improvement at the midpoint. Core funds from operation are projected in a range of $6.40 to $6.50, flat compared to the prior year.

Dividend and valuation analysis

Digital Realty raised its dividend 3.6% for the upcoming March 31 payment, giving the trust its 17th consecutive annual increase. The stock yields 3.5%.

The trust has an expected funds from operations payout ratio of 72% based on the midpoint for current year guidance, ahead of the 10-year average payout ratio of 65%. Recall that Digital Realty has had to greatly increase its share count recently. In fact, the share count has expanded more than 2.5 times over the last decade as the trust has had to issue share in order to fund acquisitions. Still, the payout ratio has remained low for a REIT. Given Digital Realty's growth over the years, share dilution appears to have been successful.

Digital Realty generated free cash flow of $1.7 billion in 2020, marking the third consecutive year of growth. This was more than enough to cover $1.2 billion of dividend distributions. Even with a vastly higher share count, the free cash flow payout ratio of 72.6% wasn't too far off the three-year average free cash flow payout ratio of 68%.

Using Friday's closing price of $133.51 and the midpoint of expected funds from operations for 2021, Digital Realty has a forward price-FFO ratio of 20.7. For context, the stock's five-year average price-FFO ratio is 18.2.

This means that shares currently trade at a 12% premium to the stock's average valuation over the medium term. This is still an elevated premium, but below last year's average valuation.

Digital Realty is also trading much closer to its intrinsic value as calculated by GuruFocus. As a reminder, the GF Value is calculated based on historical multiples, the company's past returns and growth rates and future estimates of business performance.

Digital Realty: Almost Time to Buy
Digital Realty: Almost Time to Buy

Digital Realty's current GF Value is $122.13, which means shares are trading with a price-to-GF Value of 1.09. As a result, Digital Realty earns a rating of fairly valued from GuruFocus. Looking at the chart above, you can see that the stock has rarely been this close to it s GF Value line over the last year.

Final thoughts

Unlike many names in the REIT sector, Digital Reality thrived in 2020. Revenue was up significantly due to the Interxion acquisition. Funds from operations did decline for both the quarter and full year, but this was due to a much higher share count.

Overall, Digital Realty is performing very well. The trust is expanding its footprint worldwide and saw the majority of new bookings come from international regions for the first time ever. The company also benefited from working in an area of real estate that actually saw a tailwind from the Covid-19 pandemic.

Digital Realty offers a market-beating dividend yield, low payout ratio for a REIT and a solid dividend growth streak.

I am not ready to buy Digital Realty just yet, but based on the trust's business model, which turned out to be almost pandemic-proof, and dividend history, I believe that the stock is becoming much more attractive as it declines in value. If it fell closer to the GF Value, I would consider purchasing shares of Digital Realty.

Disclosure: The author has no positions in any stocks mentioned in this article.

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This article first appeared on GuruFocus.