Buying in Tranches: Keppel DC

In the past few weeks, I sold a few of my stocks to trim my general portfolio and increased the holdings in my FOREVER PORTFOLIO.

There were several stocks that I wanted to dispose of to prune my portfolio, and I was able to sell a few of them when the price was right:

1. Hercules Capital (18.81% profit). HGTC is a great dividend player. The last time I checked, HGTC was offering 8++% dividend yield. HGTC, being a business development company,  takes on quite a lot of risks when they invest in companies that are young, struggling or developing. With risk comes opportunity, of course, but I’m taking the time to reassess my risk appetite.

2. Iron Mountain (32.43% profit). Iron Mountain is also a great dividend player but I decided to take profit. I will have to take time to reassess its business model and see if it is moving from its mature physical-storage business to a digital business fast enough to match current storage trends in the world.

3. SATS (1% loss). I didn’t want to wait for the airline industry to recover, which in my opinion, would still take a while. I’d rather put the money to better use elsewhere.

The recent correction in prices for REITs in March presented several opportunities to buy some quality REIT counters. I had the recent spike in 10-year Treasury yield and the fear of inflation, as well as renewed interest in cyclical stocks, to thank for these buying opportunities.

With new and recycled capital, I bought the following

1. Palantir Technologies (more on this in another post)

2. Ascendas Reit

3. Keppel DC Reit

Introduction

Keppel DC is the first pure-play data centre REIT in Singapore, listed in the Singapore stock market since 12 December 2014. Keppel DC’s investment strategy is to principally invest in a diversified portfolio of income-producing real estate assets which are used primarily for data centre purposes.  As at end-December 2020, Keppel DC has assets under management of approximately SGD3.0 billion. Its portfolio comprises 19 data centres strategically located in key data centre hubs in Asia Pacific and Europe (the portfolio spans 12 cities in eight countries across Asia Pacific and Europe). 

Keppel DC REIT Fact Sheet

I bought Keppel DC in 3 tranches and my average price was SGD 2.66.

I basically averaged down on my purchases of Keppel DC shares. Averaging down is an investment strategy that makes perfect sense to me here because Keppel DC is a stock that I intend to hold for the long-term. The drop in Keppel DC’s price in recent weeks was only temporary and not a sign of trouble concerning the company’s current/future performance or financial state. Since I believe in Keppel DC, the quality of its portfolio and growth prospects, I am inclined to increase my holdings in the company should the price continue to decline.

Key Highlights

1. The portfolio: In terms of trade sector and lease type, Keppel DC’s portfolio looks diversified and resilient.  However, in terms of asset location, Keppel DC’s portfolio appears to be overly concentrated in Singapore (56%).

2. Gross revenue: SGD265.571m for FY2020.  UP 38.6%, from SGD194.826m (FY2019).

3. Net property income (adjusted): SGD244.166m for FY2020.  UP 37.7%, from SGD177.283 (FY2019).

4. Occupancy rate: 97.8% (as at 31.12.2020).

5. Interest coverage ratio: 13.3x.

6. Gearing ratio: 36.2%.  

7. WALE: 6.8 years by leased area. 

Keppel DC Second Half and Full Year 2020 Financial Results: 26 January 2021

8. Weighted average interest cost:  1.6% per annum

9. Debt Maturity Profile: 3.2 years.

10. Free Cash Flow: UP 43.01%; 157.6m (FY 2020) vs 110.2m (FY2019) vs 72.47m (FY2018).

11. Net Asset Value per unit: UP 4.4%; SGD1.19 (FY2020) vs SGD1.14 (FY2019).

12. Distribution per unit (adjusted): GROWING; UP 20.5% YOY; SGD0.0917 (FY2020) vs SGD 0.0771 (FY2019) vs SGD0.0732 (FY2018).

13. Current yield distribution: 3.05%. 

14. Current PB Ratio: 2.36, (share price at SGD2.81 as at 31 Dec 2020).  So Keppel DC’s PB ratio is on the high side.  Keppel DC’s 5-year PB average is 1.7. This means for a considerable period of time, Keppel DC has not been trading below or close to its NAV. 

https://www.morningstar.com/stocks/xses/ajbu/valuation

Keppel DC has not been cheap for quite a long time, not even during the pandemic crisis in March last year.  Hence, looking to invest in Keppel DC based on fair PB value is not going to come by any time soon, probably not even during the next market correction, if the pandemic-induced correction last year was anything to go by.  Analysts have set Keppel DC’s target price to be between SGD3.20 and SGD 3.51.  I’m not sure if I agree with these target prices but I do believe that any pull back in price, like what happened a few weeks ago in March provides a good opportunity to invest in Keppel DC.  Based on DCF, I deduced Keppel DC’s fair value to be within SGD2.85 range. At my average price of SGD2.66, it is a 15% drop from its peak price at SGD3.16.  

Why did I buy Keppel DC?

Positioned for Growth: There is no denying that the future is going towards more digitalisation, and it surprises no one that data centre REITs were the best performers in the REIT sector in 2020 for the Covid-19 pandemic has demonstrated the vital importance of data centres. Data centre-provided cloud services have allowed people to collaborate remotely for work, provided entertainment for locked down citizens, facilitated online learning, and enabled everyone to shop online. The world has slowly opened up as vaccines are rolled out, but the fact remains that companies that have shifted their operations to a digital platform and adopted cloud technologies will continue to do so. The implementation of 5G technologies, and other technologies such as IoT, AI and edge computing will also further drive demand for data centres. The rise in data consumption in a growing digital economy will only drive the data centre market to thrive and outperform.

Keppel DC is well positioned to take advantage of this long-term growth in data centre demand. It has identified the following growth trends:

1. Asia-Pacific data centre spending is expected to surpass USD35 billion by 2024 to account for more than 35% of global market.. In Europe, the data centre market is expected to grow by more than 40% to over USD25 billion by 2024 in spite of limited new supply.

2. More than 70% of all hyperscale data centres (a data centre is defined as “hyperscale” when it exceeds 5000 servers and 10,000 square feet) are located in facilities that are leased or owned by partners. While Microsoft and Google have their own hyperscale data centres, they do also lease the facilities of Keppel DC.

3. Enterprise spending on cloud infrastructure expected to grow by 22%2 CAGR over next 5 years.

4. Smartphone subscription is forecasted to reach 7.5 billion in 2026, led by huge growth in less mature markets. .At the same time, 5G subscriptions are expected to reach 3.5 billion in 2026, and account for an estimated 54% of total mobile data. The real-time capability of 5G could support advancements in the use of autonomous vehicles, cloud gaming, as well as the IoT, which will in turn create more data that needs to be stored and processed in a data centre. These huge increases in traffic volumes and demand for data processing and storage will bring about more businesses for data centres, the so-called heart and muscle of telecommunication.

In view of all these developing trends in the data centre sector, is Keppel DC well-positioned to take advantage of these growth opportunities? Absolutely!

What has it done so far to grow in line with these trends? Let’s start from 2019.

In 2019, Keppel DC acquired Keppel DC Singapore 4 (KDC SGP 4) and DC1, and optimised its portfolio returns by fitting out shell and core space at DC1, and converted a large portion of vacant non-DC space at Keppel DC Singapore 5 to data centre space.

In 2020, Keppel DC completed its acquisition of its second DC, a 5-storey data centre connected to a 6-storey office block, in Kelsterbach, Germany, The town of Kelsterbach is close to Frankfurt airport and serves as an important centre for logistical service providers and chemical production.

Keppel DC also acquired a data centre and office facility in the Schiphol business park in the Amsterdam Metropolitan Area. Amsterdam DC, which is 99.1% occupied and leased to data centre and IT firms, is located near the Amsterdam Internet Exchange, one of the world’s largest hubs in terms of connections and traffic.

These acquisitions are all DPU-accretive.

Keppel DC Second Half and Full Year 2020 Financial Results: 26 January 2021

Growth opportunities are aplenty for Keppel DC, and Keppel DC has a proactive asset management well in place since its IPO days. With the increase in world-wide demand for data centre capacity, I expect to hear of future accretive acquisitions by Keppel DC.

Keppel DC’s gearing remains low at 36.2%, providing it with a comfortable debt headroom to capture growth opportunities. Low financing cost and flexibility in debt financing will help Keppel DC propel forward in its growth trajectory.

Gaining from Higher Market Rents: In view of the current demand-supply gap where demand outstrips supply, I expect market rents for Keppel DC’s properties to be bid up in the next few years. Since Keppel DC derived more than half of its revenue from its Singapore properties, it behoves me to assess its operation in the Singapore data centre market. Here’s why I think Keppel DC’s revenue will go up in the near future because of demand outdistancing supply in the data centre sector:

1. Tech Giants expanding in Singapore: When tech giants from China such as Tencent and TikTok move to Singapore to set up their operations, they will be looking for data centres to perform their smart technologies and big-data analytics. The presence and operation of these tech companies in Singapore ensure demand for data centres to remain robust in the coming years.

In expressing his optimism on data centre demand in Singapore, Mr Wong Wai Meng, CEO of Keppel DC, opined, “If you look at the Chinese OTT company and [cloud services providers], a lot of them use Singapore as a bridge to the rest of the world. It is not just international player coming to Singapore as a first hub to [enter] the Asia region, the Chinese also see Singapore as an international gateway to the rest of the world.”*

For many global companies, Singapore is their entry to Asia, and having a data centre here allows them to easily connect to other countries in the region with multiple redundancy options and the lowest latency (delay). Top tech firms like Google and Grab are also planning their growth in the region right from Singapore.

2. Data Centre Construction Moratorium: On November 9, 2020, a headline in the Business Times read “Singapore hits pause on building new data centres; short-term rents up: Sustainability is behind the moratorium; Republic has about 60 data centres guzzling electricity”**

Singapore’s land mass is only about 724 sq. km and that means there is a limit to just how many data centres can be built in Singapore. There are now about 60 data centres in Singapore.

Besides, data centres consume about 7% of Singapore’s total electricity consumption, and this data was made available in 2014! Without new data available, I can only assume the data centres in Singapore to consume more than 7% of the electricity consumption of the entire country now. With Singapore committing to reducing its carbon footprint, putting a stop to building more data centre seemed like the correct thing to do.

Singapore’s imposition of a moratorium on new data centres has triggered a short-term rental rates hike which is likely to continue to persist. The ban on creating new data centres will expire sometime this year but there is no guarantee the Singapore government will not extend this moratorium.

Keppel DC is currently exploring the development of floating data centres (which will feature a modular system which can be scared up quickly according to customers’ demand)*** and more sustainable power sources such as seawater cooling as a part of its suite of solutions for sustainable urbanisation.

Imposing this moratorium for the long term might hurt Keppel DC’s prospects in Singapore.

Singapore’s data centre operators have two main competitors right next door, namely, Malaysia and Indonesia. Both countries which have an abundance of land mass for data centre operations are developing rapidly and are expected to increase their share of the region’s data centre pie. They also have the physical capabilities to generate their own supply of renewable energy.

However, being newer to the data centre game and still at a much earlier stage of data centre development, their infrastructure is less organised and their workforce less experienced. So data centre operators in Singapore still have a good fighting chance to remain at the top in spite of the competition. Nevertheless, this constitutes a risk for Keppel DC especially when the moratorium on new data centres is imposed for years to come. As early as 2018/19, Indonesia is already challenging Singapore’s dominance in data centre investment by attracting industry giants Google, Alibaba and Amazon. I certainly do not want our neighbours to steal the business from our local boys in the data centre sector.

Bought on Price Retracement

Looking at PB ratio alone, Keppel DC is trading at a premium. It is not wise, in my opinion, to make an investment decision by looking at just one or two metrics, in this case, the PB ratio and dividend yield. There are a myriad of things that I looked at and considered before purchasing Keppel DC shares. For example,

> Is Keppel DC’s capital management prudent and are its interests aligned with shareholders’?

> Does it have gearing below 40%?

> Are the returns and growth of Keppel DC consistent?

> Do its NPI and DPU increase from year to year?

Keppel DC checks all the boxes for an excellent REIT except perhaps its high PB and low dividend yield (below 5-6%). The best time to buy Keppel DC in recent times was March 2020 (doesn’t everyone know that already?). At its lowest then, the PB was about 1.52. Because of that I didn’t buy Keppel DC at that time. Still expensive … wait for the share price to go lower, surely it will, I told myself.

Guess what happened next? Keppel DC’s share price only remained below SGD2.00 for 5 days, and there after, it took off and eventually reached the top price of SGD3.16 in October last year. I might have to wait for the next pandemic or some catastrophic event to happen to be able to get Keppel DC at a PB close to its book value!

Well, I didn’t wait. I bought Keppel DC when the share price retraced from its peak. The high valuation notwithstanding, Keppel DC is a company that I very much like to include in my portfolio. I like its growth prospects in the larger data centre sector.

Based on Fibonacci retracement, I came to a figure I was comfortable to enter for Keppel DC, a 38% retracement in price:

Move from March low to latest peak: 3.16 – 1.77 = 1.39

38% of 1.39 = 0.5282

Entry price after 38% retracement = 3.16 – 0.53 = SGD2.63

So I was comfortable with buying Keppel DC in the region of SGD2.63. My average price for Keppel DC was SGD 2.66. The next time to buy Keppel DC would be at a 62% retracement point at SGD2.30, assuming the peak price is still SGD3.16. At my average buy-in price, I’m looking at a dividend yield of 3.4%, not as much as I’d like but I’m fine with it.

Conclusion

In recent years, data centres are considered to be the 5th utility, and has been regarded as indispensable as water, electricity, gas and telecoms. The data centre industry plays a prominent role in facilitating business functions such as data backup and recovery, networking, website hosting, security, and providing support for cloud storage applications, online gaming and e-commerce transactions.

According to a study done by Cushman & Wakefield titled “2021 Data Center Global Market Comparison”, Singapore is ranked 5th in the global data centre market, the only Asian city to be in the top 10.

https://www.cushmanwakefield.com/en/insights/global-data-center-market-comparison

GlobalData.com posited that Singapore’s data centre and hosting market would grow by a CAGR of 9% from 2018 to 2023, the highest among APAC countries.

GlobalData Market Opportunity Forecasts to 2023: Data Center and Hosting

The data centre market is growing exponentially and I want to invest in a data centre REIT that combines low risk and high growth potential. Keppel DC fits the bill for me. This same investment thesis also guided my buying of more Ascendas REIT shares in March as Ascendas too is looking into acquiring 11 data centres in Europe (more on this in the next post).

A diversified portfolio of investments, each of which  is unlikely to produce significant loss, is a good start toward investment success

Howard Marks

* https://www.datacenterdynamics.com/en/analysis/singapore-data-center-market-shows-signs-saturation/

** https://www.businesstimes.com.sg/real-estate/singapore-hits-pause-on-building-new-data-centres-short-term-rents-up

*** https://www.keppeldatacentres.com/innovations/floating-data-centre-park/

____________________

Disclaimer: I am only an amateur investor and nothing you read here on my blog constitutes financial advice.  I write here to detail my investments, strategies, and analyses.  Feel free to read at your own risk.  Should you need financial advice, consult a licensed financial advisor.

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