Buy Digital Realty Trust (DLR)

03/23/2012 2:30 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

On my March 16 post http://jubakpicks.com/2012/03/16/yes-the-nasdaq-is-higher-than-its-been-since-the-tech-bust-of-2000-but-this-is-a-different-and-much-healthier-technology-sector/on investing in the technology sector—even after it has rallied so strongly at the beginning of 2012—I said don’t forget about companies that enable bigger technology trends and mentioned very briefly Digital Realty Trust (DLR) a company that owns a portfolio of 102 data centers in 31 markets serving clients that include Facebook, AT&T (T), and Morgan Stanley (MS). Organized as a REIT (real estate investment trust), I noted, Digital Realty pays a 3.8% dividend.

Let me dig a little further into this REIT because I think it’s a very interesting way to get some technology exposure for even a risk-averse portfolio.

The company makes its money from leasing space in its data centers on anything from a turn-key basis to build-to-suit to operations that range from a company’s computing center to a telecommunications network to an Internet enterprise such as Amazon.com or Salesforce.com. The bulk of its business (90%) comes from North America but Digital Realty Trust has been building out its capacity in Europe (Dublin, Paris, and London), Singapore, and Australia.

A typical deal might work start with Digital Realty buying a building from a technology company looking to lower its debt load by getting paid to convert an owned asset into a lease. Digital Realty then installs the basic infrastructure in the building, but passes on the cost of things such as fully redundant electric systems to tenants. That helps lock in clients—the company saw a 92% retention rate in 2011. On average tenants sign a lease for 14 years with built in 3% increases in annual rent. Tenants also pay for maintenance, real estate taxes, and insurance.

Even though it’s selling facility management and space to technology companies instead of apartments or retail space, Digital Realty works like a standard REIT. The company pays out 100% of taxable income to unit holders and raises money on the public debt markets to invest in building new facilities. In other words, business is pretty good when money is cheap.

As long, that is, as demand for data center space is growing. In the company’s most recent survey of North American demand, the company found that 92% of companies responding to its survey said that they would definitely or probably expand in 2012. That’s the highest percentage in the six years that Digital Realty has sponsored this survey.

In 2011 EBITDA (earnings before interest, taxes, depreciation, and amortization) climbed to $623 million from $512 million in 2010. That’s a 21.7% increase from 2010.

The company has raised its annual payout to $2.92 in 2012 from $2.72 in 2011 (a 7.4% increase) from $2.02 in 2010. That’s a 4.07% yield on the March 22 close of $71.67. (Digital Realty paid its most recent quarterly dividend to shareholders of record on March 15.)

As of March 23, I’d adding units of Digital Realty Trust to Jubak’s Picks with a 12-month target price of $78 a share for Digital Realty. With the units trading on March 22 at $71.67, near their 52-week high of $73.73, that would give an investor a 9% gain plus a 4% yield for a 13% return in a year. With a beta of just 1.04 suggesting that this REIT is not significantly more volatile than the stock market as a whole (the market’s beta is 1.00 by definition) that seems a solid potential return. Of course, you might do better. In 2011 the units gained 34.6%.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did not own shares of Digital Realty Trust as of the end of December. For a full list of the stocks in the fund as of the end of December see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

 

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