Monday, August 5, 2013
The market continues to march higher, much to the chagrin of us dividend growth investors focused on value. I do my best to keep abreast of value wherever it can be found, and my watch list for this month is mostly filled with equity positions I already own that are currently trading for prices below what I paid. Averaging down on a position requires conviction in your decision making process, and thus it's important to be confident in a company's long-term fundamentals and prospects.
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 8/1/13 for $54.75 per share.
I initiated a position in this real estate investment trust (REIT) back in June and it has since traded down on weakness amid a large short float (investors shorting the stock) and an inconsequential accounting change. Shares are down well over 7% since I first invested in this company, so I wanted to review my investment thesis and see if there was an opportunity to take advantage of Mr. Market's irrationality or if there was a real problem with the company. This stock is down approximately 20% YTD, while the S&P 500 is up approximately 20% YTD. That's a 40% spread, so this is quite an interesting stock right now. Obviously, DLR took a hit with the rest of the REITs when interest rates shot up on the back of the possibility of reduced QE, but there is a lot more to the story than that.
The company has a track record of operational excellence since going public in 2004, handily trouncing the S&P 500 during that time frame. But, as always, past results are no guarantee of future performance.
As I discussed previously, this company is under attack by Jonathan Jacobson of Highfields Capital Management LP. He has stated that incorrect reporting of CAPEX and a lack of an economic moat resulting in increased competition means this company's shares are worth about $20. Quite dramatic, but if you're interested in shorting a stock it's in your best interest to scare investors and sell their shares so that you can profit. It's working out nicely so far.
The claims on underreporting of CAPEX have been doggedly refuted by management, but DLR did make a change to how they account for CAPEX which seems to have scared some investors on the premise that Jacobson and the shorts are right and this company is in trouble. From the research I've conducted, the change was actually quite inconsequential and amounted to an adjustment of about $3.4 million to AFFO for the second quarter. The second quarter was otherwise quite strong with an 11.2% increase in FFO over 2Q 2012 and the acquisition of two properties totaling nearly 354,00 square feet. The business just keeps chugging along even as the price continues to dive.
As far as the strength of the business, it's true that DLR might lack a strong moat because there isn't really anything to keep competitors from trying to open data centers of their own. However, I don't see how this is a zero sum game and this fact has been true for the last nine years that DLR has been a public entity. There are some that have the opinion that server farms might go the way of the dinosaur as servers become smaller and cloud computing somehow steals demand from DLR. Again, I just don't agree with this. Cloud computing wasn't something that started yesterday, and DLR has done quite well as technology and computing has changed over the last decade. In addition, I can't imagine how the need for data, computing and storage doesn't increase over time. Much in the same way that demand for consumer products will likely increase over time as the global population increases and middle class consumers rise up in emerging countries, these same consumers will demand companies to increase their usage of data and information. And then, of course, you have the increasing usage of smartphones and tablets which also require more and more data. DLR appears to be well positioned to take advantage of any growth that happens with these trends due to being located in key markets across the globe.
The risk/reward profile of this REIT is a bit more aggressive than most of the other companies I've invested in, and the price may continue to go down from here. But this trust represents a little less than 2% of my portfolio, so I'm okay with the risks involved. And those risks are being amply rewarded. The entry yield on my purchase price on this security is 5.7%, which is obviously very attractive in the current environment. And with my purchase being just above the 52-week low in a market that continues to set record all-time highs, I feel comfortable. The main issue with this REIT, in my opinion, is that they are so closely tied to tech and the rapidly changing nature inherent in such. But as I pointed out above, they've navigated their business very well thus far.
DLR is currently trading with a P/FFO of about 12 right now. This REIT has a compound annual FFO growth rate of 18.7% since they went public and the dividend has a CAGR of 15.3% since 2005. The most recent dividend raise was 6.8%, which may be a good indication of the growth going forward. I valued shares when I first initiated my position a couple of months back, and I came up with a Fair Value of just over $65 per share using a Dividend Discount Model with a 10% discount rate and a 5% long-term growth rate. If that number is reasonable (which I believe it to be), then a comfortable margin of safety exists at today's price.
I'm now done buying shares in DLR, as this represents a full allocation to this company for me right now. Again, shares may continue to go down due to the large percentage of the float that's being shorted, but that isn't what concerns me. What does concern me is the quantitative fundamentals of the company and whether they're able to continue to grow at a robust rate while rewarding shareholders through a growing dividend. And I feel they will be able to do so. When a business has a falling share price that is backed by crumbling fundamentals that would be a good time to sell. But when a business has a falling share price with otherwise solid fundamentals and growth, I look to purchase. Investors appear to be fearful with DLR, so I will be greedy.
This purchase adds $62.40 to my annual dividend income based on the current $0.78 quarterly dividend.
I'm currently invested in 37 companies, as this was an addition to a company I already have an ownership stake in.
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 September to reflect my recent addition.
Full Disclosure: Long DLR
How about you? Believe in the long-term story of DLR or are you selling?
Thanks for reading.