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Is Digital Realty Trust a Value Trap?

November 01, 2013 | About:
I didn't actually plan on purchasing any more equities for the month of September. I was quite satisfied withinitiating an investment in Exxon Mobil Corporation (XOM) and the addition of additional shares in my burgeoning position in Baxter International Inc. (BAX). However, sometimes I'm compelled to purchase equity when the market punishes shares in a company for one reason for another. When Mr. Market is feeling depressed about a particular security and the fundamentals remain reasonably appealing, I'm feeling positively joyous.

As part of my Recent Buy series, I try to let my readers know of any equities I purchase soon after the transaction is completed. This is just one way I try to document my progress toward early retirement and financial independence.

I purchased 20 shares of Digital Realty Trust, Inc. (DLR) on 10/31/13 for $46.74 per share.

This was an interesting purchase for me. I actually wasn't particularly interested in adding to my DLR position at all. I never planned on it being a large position, and instead due to the risks involved and exposure to heavily changing technology pursued a strategy to keep it as a low weighting within my portfolio. You could make a case this is a falling knife, but shares have actually been recovering quite nicely over the last few weeks. Up until Wednesday, that is. On October 30, shares were down over 15%. Quite the horror if you're a shareholder like myself. Shares were down another 5% or so at one point on Thursday. That's when I decided to take a stand: do I believe in this company or not?

I revisited my original thesis, as I laid out when I published my purchases of shares in DLR back in June for$59.34 per share and August for $54.75 per share. I view the future as bright for this company as data usage continues to be consumed at exponential rates and DLR appears to be well positioned in key markets around the globe to take advantage of this trend and data center outsourcing. The reasons for investing haven't really changed since then and fundamentals are basically the same, but DLR did have a rough Q3 - which explains much of the recent weakness.

DLR reported third quarter results Tuesday after the bell, and to state the obvious the market didn't like what DLR had to say. Diluted FFO came in at $1.10 per share, which is less than $1.13 per share in Q312. Without a non-cash adjustment to core FFO due to rent expense adjustment from a New York property, FFO would have been $1.16 per share. That would certainly be better, but still would have missed analyst expectations of $1.20 per share. I view quarterly misses as great opportunities to invest in high quality companies at opportune times; maybe the miss was slight, maybe not - but analyst expectations aren't always reasonable anyway. Sometimes great businesses have a rough quarter or two.

However, DLR appears to be guiding future FFO down a bit, with a narrow guidance for 2013 FFO at $4.60-$4.62, down from $4.73-$4.82 previously. A bit troubling, but not sure if a 20% hit to the market cap is quite appropriate for a ~4% change in guidance. At any rate, it happened and I'm quite glad.

You know, it's funny. People talk all the time about buying "when there's blood in the streets". Believe me, it's much tougher to do so when the blood is spilling and some of it might be your own. But I take pride in this blog, and my purchases, being live and loud. You can see all of my greatest hits and misses, but most of all I'm glad you can see that I put my money where my mouth is. I talk about being glad when shares I own decline in price, and you can see that maxim in action here.

There continues to be risks with DLR here. Lowered guidance means the company is having a hard time meeting its objectives. Acquisitions of income-producing properties have slowed and lease commencement have been delayed, which DLR cites as being due to "reflecting the needs of strategic customers for phased delivery of custom-built space for large-scale requirements on long lease terms."

But I'm a long-term investor. That means years, or decades. That doesn't mean a quarter here or a quarter there. I think the future looks bright for this firm as well as the space they operate in. They signed new leases totaling $47 million of annualized rental revenue during Q3. The dividend is well covered by FFO, and at current prices shares now yield 6.5%. The company appears committed to growing the dividend, and I believe that will continue. DLR also announced a $500 million share repurchase authorization, which works out great while the shares are this cheap. Based on 2013 FFO, shares are now trading for a P/FFO of 10.3.And while I see growth slowing down from the phenomenal pace DLR has enjoyed for the past decade, shares aren't priced for growth here. They're basically priced for no growth. So any surprise to the upside is all gravy, in my opinion.

I'm not going to revisit all the details on the company, as you can view my previous two 'Recent Buy' articles for that, but I wanted to take the time on this post to remind all of you out there to always know where you stand on a company. If a 20% drop causes you illness and a strong desire to sell you may not want to invest in a company at all. I would certainly agree completely that DLR is much riskier than your average blue-chip dividend growth stock, but the numbers are compelling even with the anticipated slower growth. I'm happy to purchase shares on the severe dip.

DLR has grown the dividend by a compounded annual growth rate of 15.3% since 2005. Although that growth is likely to slow dramatically going forward, I still think mid-single-digit growth is likely - on par with expected 2014 FFO growth. The last dividend raise was 6.8%, which may give investors a fair outlook for growth in the future.

I valued the shares back in August using a Dividend Discount Model analysis and came up with a fair value on shares of just over $65 per share using a 10% discount rate and a long-term growth rate of 5%. I think this represents a reasonable assessment of what shares are worth, but right now Mr. Market certainly disagrees. In the short-term anything can happen (especially with a large short float), but I think over the long haul the shares in DLR will be valued accordingly assuming the company performs well. In the meantime, I'll continue collecting a robust dividend.

This purchase adds $62.40 to my annual dividend income based on the current quarterly payout of $0.78.

I currently still have 42 positions in my portfolio, as this was an addition to an existing investment.

I usually like to include analyst opinions, but since neither Morningstar nor S&P Capital IQ track this stock I'll include an analysis from my fellow dividend blogger Dividend Monk. Although it's a few months old, the information is still extremely relevant:

Digital Realty Trust (): Trap or Value?

I'll update my Freedom Fund in early November to reflect my recent addition.

Full Disclosure: Long DLR

How about you? Is this a value play or value trap?

Thanks for reading.

About the author:

Dividend Mantra
Trying to retire by 40 by investing in dividend growth stocks and living frugally, valuing time over money.

Visit Dividend Mantra's Website


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