Investors certainly have high hopes for Keppel DC REIT (SGX: AJBU). The data centre-focused real estate investment trust (REIT) has seen its unit price soar 25% this year, with units currently trading 61% above book value and sporting a relatively low annualised yield of 4.5%.
To put that in perspective, the average REIT in Singapore trades at a 6% premium to book value and has a 6.1% yield. With Keppel DC REIT priced at a large premium to the broader market, can it deliver the growth that investors expect?
Internal growth engines
Keppel DC REIT can ride on the tailwinds of the growth in demand for data centre space, with demand supported by growth in data creation and storage requirements. The higher demand should translate to higher rental rates when its current leases with tenants expire.
In addition, there are three data centres in its portfolio that are undergoing expansion or enhancements. These are scheduled for completion either in the second half of 2019 or 2020.
There is also limited expiries in 2019 and 2020, which should provide high income visibility.
The gamer changer
However, the real game changer will be how the REIT utilises its debt headroom. Keppel DC REIT is in a great position to make accretive acquisitions. It has a conservative gearing ratio of 31%, below the gearing limit of 45% and the average gearing ratio of 34.6% among REITs in Singapore.
Just as importantly, the REIT has been able to secure debt at relatively low rates. As of 30 June 2019, it had an average cost of debt of just 1.7% and its interest expense was 12.9 times covered.
Its high interest cover and low gearing will provide it with the flexibility to make debt-funded acquisitions in the future to drive distribution per unit (DPU) growth.
The Foolish conclusion
Organic growth and the completion of the three asset enhancement works in its portfolio will perhaps account for a high single-digit to teen increase in DPU. However, based on its current yield of 4.5%, Keppel DC REIT needs a 35% increase in DPU to match up to the average yield of other REITs in the market.
To achieve that, the REIT needs to flex its financial muscle to make yield-accretive acquisitions. Ultimately, it all depends on management’s ability to find the correct investment opportunity to fully utilise its capital structure.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Jeremy Chia does now owns units in any companies mentioned.