Keppel DC REIT: Collaboration instead of litigation
- FY23 DPU of 9.383 Scts missed our projections by c.6%, entirely due to the rental default at Guangdong DCs
- KDCREIT is prioritising a collaborative but firm approach in its discussions with the tenant rather than litigation
- Revised estimates assume absence of income from Guangdong DCs in FY24; c.15% downward revision in DPU
- Maintain BUY but lowered TP to S$2.20
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Conversely, NPI declined 3.0%, totaling S$245.0m. This dip in NPI was primarily a consequence of provisions made for uncollected rents from the Guangdong DC, amounting to more than S$10.5m in FY23. Additionally, there were further provisions, totaling S$0.7m (in other trust expenses), specifically allocated for uncollected coupon payments from Guangdong DC 3.
Portfolio occupancy rates remained stable q-o-q at 98.3%. Portfolio occupancy rates for FY23 remained steady q-o-q at 98.3%. While there was a minor dip in occupancies in some of the Singapore data centres, it was effectively offset by an improvement in occupancy at KDC Dublin 1.
Looking ahead, it's noteworthy that c.50% of leases, based on rental income, are set to expire over the next two years. Specifically, 27.5% of leases are due for renewal in FY24, with an additional 22.9% slated for renewal in FY25. Despite this upcoming lease turnover, we believe there is potential for positive rental reversions given the current upward trajectory in rents.
Gearing and borrowing costs inched up to 37.4% and 3.6% in 4Q23. In 4Q23, the gearing ratio marginally increased by 20bps q-o-q to 37.4%. Simultaneously, borrowing costs saw a modest rise of 10bps to 3.6% as a result of higher floating rates. With c.74% of loans hedged to fixed rates, we do not anticipate any further significant movements in overall costs in the medium term.
Looking ahead, while we expect borrowing costs to continue inching up as loans are refinanced, we expect the impact to be minimal, as only c.4.0% of loans will be due in FY24.
Portfolio valuations held up in most markets. In the valuation assessment at end-December 2023, certain regions experienced marginal declines, including Australia, China, Malaysia, Germany, and the UK. These declines were primarily attributed to the prevailing high interest rate environment and translation losses incurred. Despite this, the portfolio demonstrated resilience with an overall revaluation gain observed in Singapore and the Netherlands, effectively offsetting the losses incurred in the other markets. The collective revaluation gains for the entire portfolio amounted to c.S$15m, underscoring the diversified nature of KDCREIT's assets and its ability to navigate regional variations.
Despite ongoing challenges with the master leases at the Guangdong DCs, the valuation of the assets held up relatively well. This stability is attributed to the valuation being based on existing lease agreements, without accounting for current rental arrears by tenants. It's important to note that the valuation might face a substantial impact if the master leases were to be removed, reflecting the potential vulnerability of the valuation metrics to changes in lease agreements.
Positive development regarding litigation against DXC Technology. DXC's current lease with KDCREIT at Keppel DC Singapore 1 extends until March 2025, covering approximately 20,300sqft or about 18.5% of the property's NLA. Despite DXC's request to return a portion of the space in April 2021, KDCREIT has not granted approval, resulting in annual rent arrears of about S$3.7m for the contested area, and S$14.8m for the four years of the lease.
Following a recent High Court ruling in favour of KDCREIT, acknowledging their claim for outstanding rents in FY21, it was also affirmed that KDCREIT has the right to reject DXC's proposal for downsizing its space. The trial, slated to begin in February 2024, assumes crucial significance as the initial court decision strongly suggests KDCREIT's high likelihood of securing the complete rental payment from DXC. Nevertheless, KDCREIT has displayed prudence by making provisions for the unpaid rents, which thus constitutes less than 2% of DPU. Any amounts successfully claimed from DXC would serve as a positive boost to KDCREIT's overall DPU.
Working with Guangdong DCs’ tenant on a recovery roadmap. The master tenant, Neo Telemedia, at KDCREIT's three data centres in Guangdong has been in default of rents since September 2023. In response, KDCREIT issued a letter of demand in December 2023, seeking a total of c.S$15.1m from Neo Telemedia, which includes rent arrears, late payment interest, and real estate taxes, as well as a top-up of security deposits.
Additionally, the completion of the fitting-out of Guangdong DC 3, initially slated for 2023, has faced delays. Out of the total property value of RMB760m, KDCREIT has deposited RMB100m. While KDCREIT retains the option to cancel the acquisition and seek a refund of the deposits paid, no such action has been taken thus far.
We understand that KDCREIT is currently in active discussions with the master tenant on the uncollected rents and future rental obligations. At this point, the REIT has not provided any concrete plans or timeline on the recovery of arrears, but we understand that the tenant remains very willing to collaborate and iron out plans. As highlighted previously, the absence of income from all three Guangdong DCs could have a significant 15%-16% impact on our FY24 DPU projections.
Some other alternatives that could be considered are the sale of the Guangdong DCs to third parties, or intervention by KDCREIT or their sponsor to assume leasing responsibilities for the affected data centres. However, it's crucial to note that these are just potential alternatives that KDCREIT could consider in the event the recovery roadmap negotiations with the tenant hit a roadblock.
Our view
The healthy portfolio occupancy and positive rental reversions present encouraging indicators, especially considering the upcoming renewal of approximately 50% of leases in the next two years. This demonstrates the resilience of KDCREIT's portfolio amid market fluctuations. The global demand for data centres remains strong, ensuring low vacancy rates and supporting the growth in rents, which bodes well for the REIT.
Despite facing challenges on the capital management front, KDCREIT has maintained a relatively stable gearing of 37.4% and borrowing costs are at 3.6%. The expectation of a marginal increase in borrowing costs is tempered by limited refinancing due in FY24 and a significant proportion of loans already hedged to fixed rates.
In response to the ongoing situation with the Guangdong DCs, we have revised our estimates to assume no income contribution from it for the entirety of FY24. Earnings are projected to resume in FY25, with underlying utilisation starting at 50% and gradually improving in subsequent years. This adjustment has led to a slightly more than 15% reduction in our FY24 DPU estimates and cuts ranging from 8%-11% over the subsequent years.
Our TP has been lowered to S$2.20 in light of the revised earnings estimates. However, the BUY recommendation is maintained, driven by the positive outlook for the rest of KDCREIT's portfolio, which continues to benefit from the structural growth in the data centre space. Additionally, the potential for a sooner-than-anticipated resolution to the rental defaults serves as an immediate catalyst, emphasising the REIT's potential for recovery, with it having declined approximately 14% since concerns first surfaced.
Key areas to watch: i) Resolution regarding the rental defaults by Bluesea for the Guangdong DCs, ii) further downside to our projections if the absence of income from the Guangdong DCs extends beyond FY24, iii) resolution on the litigation with DXC (will help provide some buffer), and iv) any impact to its portfolio valuations and gearing if the Guangdong DCs are vacated.
FY Dec | 2H2022 | 1H2023 | 2H2023 | % chg yoy | % chg hoh |
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Gross revenue | 142 | 140 | 141 | (0.7) | 0.2 |
Property expenses | (12.5) | (13.1) | (23.1) | 85.6 | 76.5 |
Net Property Income | 129 | 127 | 118 | (9.1) | (7.7) |
Other Operating expenses | (13.6) | (18.0) | (15.4) | 13.1 | (14.2) |
Other Non Opg (Exp)/Inc | 0.0 | 0.0 | 0.0 | - | - |
Associates & JV Inc | (9.0) | (2.4) | (5.9) | 34.5 | 144.6 |
Net Interest (Exp)/Inc | (12.8) | (17.2) | (20.4) | (59.0) | (19.0) |
Exceptional Gain/(Loss) | 0.0 | 0.0 | 0.0 | - | - |
Net Income | 93.9 | 89.8 | 75.9 | (19.2) | (15.5) |
Tax | (21.9) | (7.8) | (7.8) | (64.5) | (0.6) |
Minority Interest | (1.7) | (1.6) | 2.09 | nm | nm |
Net Income after Tax | 70.2 | 80.4 | 70.2 | (0.1) | (12.7) |
Total Return | 139 | 80.4 | 42.3 | (69.5) | (47.4) |
Non-tax deductible Items | (44.8) | 10.9 | 38.3 | nm | 252.2 |
Net Inc available for Dist. | 93.7 | 91.3 | 80.6 | (14.0) | (11.7) |
Ratio (%) |
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Net Prop Inc Margin | 91.2 | 90.7 | 83.6 |
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Dist. Payout Ratio | 100.0 | 100.0 | 100.0 |
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