(Published Feb. 15 by Bob Ciura)
There is an abundance of data that comes from our devices. Real estate investment trusts, or REITs, that own properties used to store this data—like Digital Realty Trust Inc. (DLR, Financial)—have benefited tremendously from our love of the internet.
The stock rose 33% in the past year alone, not including dividends.
Even better, Digital Realty has raised its dividend for 11 years in a row, every year since its 2004 initial public offering.
This makes it a Dividend Achiever, a group of 272 stocks with at least 10 years of consecutive dividend increases.
You can see the full Dividend Achievers List here.
Digital Realty last increased its dividend on Feb. 17, 2016.
The company is set to announce fourth-quarter and full-year 2016 financial results on Feb. 16. It is likely to announce a dividend increase at that time as well.
This article will analyze Digital Realty’s financial performance since the last dividend raise and discuss what investors should expect for the 2017 dividend increase.
Business overview
Digital Realty owns a portfolio of turn-key, interconnection and colocation properties. The company is diversified, both in terms of geographic markets and industries serviced.
Source: 2017 Investor Overview Presentation, page 18
Its real estate properties are located around the world. Digital Realty has 199 data centers in North America, 30 in Europe and seven in the Asia-Pacific region. It services more than 2,000 customers from multiple industries.
Digital Realty’s client base is filled with highly stable, established companies.
Source: 2017 Investor Overview Presentation, page 19
Digital Realty operates in a high-growth industry. Data storage is booming, which has resulted in consistent growth in lease signings and rental revenue for the past several years.
Source: 3Q Earnings Presentation, page 9
Digital Realty’s high-quality tenant base provides the company with steady cash flow. Occupancy stood at 92.6% through the first three quarters of 2016.
Over the same nine-month period, rental revenue increased 15%. This helped Digital Realty’s funds from operations, a commonly utilized substitute for earnings per share, increase 10% over the first three quarters of the year.
For 2016, Digital Realty expects to generate core funds from operations between $5.65 and $5.75 per share.
At the midpoint, this range would represent 8.3% growth from the $5.26 of core funds from operations per share earned in 2015.
Growth prospects
Digital Realty’s strong growth in recent years is due mostly to the boom in data center demand. This trend is expected to continue moving forward.
Because of this, Digital Realty still sees an opportunity for growth up ahead since industry economies remain supportive of it. In many top-tier U.S. markets, demand continues to exceed supply.
Source: 3Q Earnings Presentation, page 5
Furthermore, the main growth drivers for the company—the internet, video, cloud and mobile—remain intact.
Source: 2017 Investor Overview Presentation, page 16
This fundamental tailwind presents a long-term growth trajectory for the company.
Aside from data centers, the interconnection and colocation businesses are growing rapidly as well. These two businesses generated 18% growth in lease signings in the U.S. last quarter.
To further its growth, Digital Realty maintains an aggressive acquisition strategy. This is typical for REITs—acquiring new properties provides new rental income. In turn, this cash flow helps pay for additional properties, which creates additional growth.
The company conducted several acquisitions in the third quarter, the biggest of which was an $874 million acquisition of eight data centers in Europe that were previously owned by Equinix Inc. (EQIX, Financial).
Strategic deals like these complement Digital Realty’s existing portfolio, which allows the company to realize significant cost synergies. The company expects the Equinix acquisition to be accretive to funds from operations going forward.
Dividend analysis
Another important factor to assess with REITs is their balance sheets. Since REITs rely heavily on external financing, higher interest rates pose a real threat.
The Federal Reserve has indicated its desire to raise interest rates three times in 2017. This would raise the cost of capital for Digital Realty.
Fortunately, the company has a strong balance sheet. It holds a credit rating of BBB from both Standard & Poor’s and Fitch Ratings, with a stable outlook.
The company enjoys ample liquidity with $36 million in cash on the balance sheet and $1.8 billion remaining available under its $2 billion credit revolver.
Source: 2017 Investor Overview Presentation, page 38
Moreover, at the end of the third quarter, Digital Realty held a net debt-to-adjusted EBITDA ratio of 5.1 times and a fixed charge coverage ratio of 3.4.
These are reasonable debt metrics for a REIT. Along with its positive credit ratings, the company should be able to effectively raise capital at attractive rates moving forward.
Digital Realty’s sound financial condition helps the company return excess cash flow to shareholders.
Additionally, the boom in demand for data centers has provided the company with growth over the past year. Digital Realty generates funds from operations well above its dividend payment.
Digital Realty’s 2016 dividend increase was a 3.5% hike. This was below its average raise over the last several years.
Source: 2017 Investor Overview Presentation, page 30
Due to its continued growth, it is reasonable to expect Digital Realty to accelerate its dividend growth rate from 2016.
For example, a 4% to 6% dividend increase would be appropriate given the company’s strong fundamentals.
Final thoughts
With their high dividend yields and regular dividend growth, it is easy to see why income investors like REITs. A significant portion of the Dividend Achievers list is populated by REITs, including Digital Realty.
Digital Realty has a current dividend yield of 3.3%. This is above the 2% average in the S&P 500.
Digital Realty’s dividend yield, however, is below that of many other REITs, which commonly yield 4% to 5% or more in some cases.
Digital Realty’s low dividend yield is the result of its rapid share price appreciation over the past two years.
Fortunately, the company is likely to announce a dividend increase on Feb. 16. While its dividend yield has declined, it still has an above-average dividend payout in comparison to the S&P 500 Index.
Disclosure: I am not long any of the stocks mentioned in this article.
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