On March 15 I added Digital Realty Trust (DLR) to my Special Report: 10 Stocks for an Earnings Recession on my subscription JubakAM.com site. With this post, I’m also adding Digital Realty to my Dividend Portfolio.
For Digital Realty Trust (DLR), a REIT that owns 198 data centers in 32 metropolitan areas with 2,300 customers, the case for stable earnings growth–one of my criteria for stocks to own during the earnings recession that’s looming for 2019–is pretty solid. The company’s top 10 customers include IBM, Oracle, Verizon, Microsoft (via Linked In), companies that are likely to keep paying their bills. Digital Realty has grown FFO–an accounting term used by REITs to define cash flow from operations–per share for 13 straight years. Cash flow available to pay dividends has grown by a compounded 12% a year. Digital Realty just raised its dividend again for the first quarter by 6.9% to a quarterly $1.08 a share. That pushed the forward yield to 3.83% as of the close at $115.37 on March 14. (The company did miss Wall Street projections for earnings and revenue in the fourth quarter on February 19. The drop from $118.49 to $111.99 on those results has taken a bit of risk out of the stock. The stock has climbed back from the miss on the strength of a new buy rating from Deutsche Bank.)
And the company’s relative insulation from a slowing global economy is clear. 82% of the company’s revenue in 2018 came from the United States. Another 9% came from the United Kingdom and 4% from the European Union. Nothing from China.
But where is the near-term catalyst that I’m looking for in the 10 picks for my Special Report: 10 Stocks for the Earnings Recession?
Found a long-term catalyst I did (without even flexing my inner Yoda.) During the reign of 4G technology, the mobile data flow has grown 17 times in the last five years. 5G, which will allow data speeds up to 20 times faster than 4G, will just accelerate that growth. Which is great for a business that makes its money operating data centers. But that’s a long-term catalyst for the quarters after mobile operators finally roll out 5G.
How about now? Remember the stock picks in this Special Report are intended to gain during the potential earnings recession of the first three quarters of 2019.
Well, you have to dig a little but the near-term catalyst is there. With the acquisition of Telex in 2015, Digital Realty has been shifting its focus from the operation of wholesale data centers toward the operation of data centers that offer interconnection services that allow the high-speed linkage of multiple data providers inside a single center or between centers. As companies have moved more and more of their data operations to the hybrid cloud models, they have seen a rise in the need to interconnect all the data in the cloud no matter what its source and an increased demand for the ability to move that data at high speed among all the machines that make up their cloud operations. Prior to the acquisition of Telex, a specialist in these interconnection technologies, Digital Realty got 95% of its total revenue from operating wholesale data centers and received no revenue from interconnections. By the end of 2018 wholesale revenue had fallen to 77% of total revenue, while collocation revenue and interconnection revenue had climbed to 13% and 10%, respectively. Do I need to point out that interconnection and collocation operations provide higher margins than revenues from wholesale data center space?
The addition of higher margin collocation and interconnect operations to the mix is one reason that Morningstar projects that EBITDA (earnings before interest, taxes, depreciation, and amortization) margins will climb to almost 64% in 2028 from 23% in 2018.(There are other reasons too–Digital Realty, which has about 60% more leasable square feet than competitor Equinix (No. 2 in the sector by leasable space), uses its advantages of size to negotiate cheaper electricity rates from utilities and to buy generator and air conditioning equipment at what Morningstar calls “modest” discounts. I’d note that even “modest discounts” can add up when you are one of the largest consumers of those products in the world. Operating margins for Digital Realty have averaged 25% since 2010 against 19% for Equinix.
In this age of increasing action on global warming, being a huge consumer of electricity isn’t a plus. Digital Realty has set a goal of powering its data centers with 100% renewable energy. In 2016 it used 1.38 gigawatts of renewable energy and operated 55 certified green buildings. Its PUE–power usage effectiveness efficiency measure–climbed by 20% from 2014 to 2017 in buildings the company enlisted in the U.S. Department of Energy’s Better Buildings Challenge.
As of March 15 I’m adding this REIT to my list of 10 Stocks for the Earnings Recession Special Report and to my Dividend Portfolio.