Well guys, I’m doing the best I can in this market. I’m not seeing a ton of compelling opportunities out there, but I do see that Real Estate Investment Trusts as a group have taken quite a tumble lately. It could be due to a rotation out of higher yielding securities and into cyclical plays, or it could be that the Federal Reserve Chairman, Ben Bernanke, has hinted toward a tapering of QE if the economy continues to improve (which could cause interest rates to rise). It’s not really my concern as to the “why”, but rather the “how can I take advantage of this”. And the best way I can think of to take advantage of this situation is to start purchasing high quality real estate investment trusts at attractive long-term prices relative to intrinsic value.
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.
DLR was not even on my radar until very recently. Some of you readers started commenting about the company and hinted that it could be a good value at current prices. So I decided to do some due diligence and find out as much about the company as I could. I liked what I saw and after seeing the stock fall almost 3% on Monday (with the Dow Jones up almost 1% for comparison), I decided to initiate a position with this REIT.
DLR has been particularly weak lately, and is down -13.48% over the last month. This is likely due to the fact that REITs have been weak in general, but also because a hedge fund manager, Jonathan Jacobson of Highfields Capital Management LP, stated it’s a stock to sell short and is only worth $20 per share. I didn’t view the argument as particularly compelling, but I’m glad he made it public because DLR has become a pretty attractive value after the comments were made in early May.
DLR is a Real Estate Investment Trust that owns data centers and leases them out to high quality tenants with long-term leases in place. They own 122 properties with 22.7 million rentable square feet in over 30 markets throughout the world. They have approximately 2,000 leases with over 550 tenants. While North America currently accounts for about 80% of their annualized rent, Asia is a big growth opportunity for the company and they currently own properties in Hong Kong and Singapore. They are looking to expand aggressively in China and Japan.
They work with three different sets of clients. First is Colocation & Cloud, Managed Service Providers/System Integrators (think International Business Machines (IBM)). Second is Corporate Enterprise Users (think PepsiCo, Inc. (PEP)). Finally, we have International Network & Telecom Providers (think AT&T Inc. (T)).
While no single tenant accounts for more than 9.1% of annualized rent, they aren’t as diversified as some of the other REITs I’ve looked at. They do have some very high quality tenants to count among their biggest clients, however, like Facebook Inc (FB), AT&T Inc. (T), Verizon Communications Inc. (VZ) and Morgan Stanley (MS). The great thing about DLR is that they have consistently high same store occupancy rates (typically above 93%) due to high barriers to exit (typically tenants have considerable equipment and technology in place). They should continue to see very stable, and rising income streams going forward as their average lease term still has 6.9 years remaining. Also, as IT and cloud computing continue to grow DLR should see a continued piece of that pie. The great thing about this company is that there are high barriers to entry as new data centers require significant capital and specialized experience. These buildings also require specific cooling and electrical needs that can’t be served through normal retail structures.
What really struck me about DLR when I started to look into the company was the history of spectacular growth since they went public late 2004. They have a compound FFO growth of 18.7% since that time, which is phenomenal. The dividend growth is obviously one of the first places I looked and they’ve growth dividends by a CAGR of 15.3% since 2005. Again, phenomenal. Especially considering the high yield you get with this security. The current entry yield on this stock is 5.27%. I don’t anticipate the dividend growth to continue at such a robust rate, but I’d be happy with mid-to-high single digit FFO and dividend growth. The most recent dividend increase was 6.8%, with the new dividend payout at $0.78 quarterly per share over the old rate of $0.73 quarterly per share.
Looking at the valuation, DLR is fairly attractive here. I would ignore the P/E ratio on this one because REITs are better valued by using FFO (Funds From Operations) which represents earnings with depreciation and amortization added back in to give a more accurate picture of how profitable the enterprise is. The P/FFO is right about 12.9 right now. Using a Dividend Discount Model while using the same assumptions (10% discount rate and 5% long-term dividend growth rate) as I used with my recent purchase of another REIT (Realty Income Corp. (O)) I get a Fair Value on shares at $65.52. I think a margin of safety exists here of at least 10%, and this is one of the better opportunities in the market if you believe in the long-term story of increased data storage needs, server businesses and cloud computing (which I do).
I’m likely done buying REITs for a while now as I wanted to dip my toes into this sector and get my feet wet. I think there is some value to be found here but typically I like to concentrate on companies with significant competitive advantages via brand name products or proprietary services, significant economies of scale, lengthy history of share buybacks and dividend raises (I always prefer the latter). REITs typically have lower dividend growth and have to issue new shares to fund acquisitions and growth, so while I appreciate the high yield they offer my portfolio for current income to “supercharge” my reinvestment abilities, I plan to keep REIT exposure to 5-7% of my entire portfolio.
This purchase adds $78.00 to my annual dividend income based on the current payout.
I currently have 34 positions in my portfolio after this purchase, as DLR is a new investment.
I usually like to include analyst valuation opinions on my purchases, but neither Morningstar nor S&P Capital IQ track this stock.
I’ll update my Freedom Fund in early July to reflect my recent addition.
Full Disclosure: Long DLR, O, PEP, T
What are you buying? See any compelling values out there?
Thanks for reading.