Digital Realty Trust Inc is a US$23.7b large-cap, real estate investment trust (REIT) based in San Francisco, United States. REITs own and operate income-generating property and adhere to a different set of regulations. This impacts how DLR’s business operates and also how we should analyse its stock. I’ll take you through some of the key metrics you should use in order to properly assess DLR.
REIT investors should be familiar with the term Fund from Operations (FFO) – a REIT’s main source of cash flow from its day-to-day business activities. FFO is a higher quality measure of earnings because it takes out the impact of non-recurring sales and non-cash items such as depreciation. These items can distort the bottom line and not necessarily reflective of DLR’s daily operations. For DLR, its FFO of US$1.0b makes up 65% of its gross profit, which means the majority of its earnings are high-quality and recurring.
DLR’s financial stability can be gauged by seeing how much its FFO generated each year can cover its total amount of debt. The higher the coverage, the less risky DLR is, broadly speaking, to have debt on its books. The metric I’ll be using, FFO-to-debt, also estimates the time it will take for the company to repay its debt with its FFO. With a ratio of 12%, the credit rating agency Standard & Poor would consider this as aggressive risk. This would take DLR 8.62 years to pay off using just operating income, which is a long time, and risk increases with time. But realistically, companies have many levers to pull in order to pay back their debt, beyond operating income alone.
I also look at DLR’s interest coverage ratio, which demonstrates how many times its earnings can cover its yearly interest expense. This is similar to the concept above, but looks at the upcoming obligations. The ratio is typically calculated using EBIT, but for a REIT stock, it’s better to use FFO divided by net interest. With an interest coverage ratio of 3.96x, it’s safe to say DLR is generating an appropriate amount of cash from its borrowings.
In terms of valuing DLR, FFO can also be used as a form of relative valuation. Instead of the P/E ratio, P/FFO is used instead, which is very common for REIT stocks. In DLR’s case its P/FFO is 23.2x, compared to the long-term industry average of 16.5x, meaning that it is overvalued.
Digital Realty Trust can bring diversification into your portfolio due to its unique REIT characteristics. Before you make a decision on the stock today, keep in mind I’ve only covered one metric in this article, the FFO, which is by no means comprehensive. I’d strongly recommend continuing your research on the following areas I believe are key fundamentals for DLR:
- Future Outlook: What are well-informed industry analysts predicting for DLR’s future growth? Take a look at our free research report of analyst consensus for DLR’s outlook.
- Valuation: What is DLR worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether DLR is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.