Sustainability And Innovation Drive Growth In Data Center Space

Key Takeaways

• Expanding into new markets and developing data centers for AI workloads positions the company for additional growth opportunities and competitive advantage.
  
• High demand for data center capacity and a significant backlog of leases indicate strong future revenue growth from larger capacity blocks and services.
  
• Increasing competition, regulatory and environmental challenges, technological shifts, reliance on hyperscale data centers, and exchange rate fluctuations could impact revenue, net margins, and earnings.

Catalysts

Digital Realty brings companies and data together by delivering the full spectrum of data center, colocation, and interconnection solutions.

• High demand for data center capacity, especially in core markets, indicates a favorable environment for future revenue growth from larger capacity blocks and interconnection services.
  
• Record levels of new leasing and a significant backlog of signed but not yet commenced leases suggest strong future revenue growth as these leases commence.
  
• A strategy focused on reducing leverage below the long-term target level could improve financial flexibility and support future growth initiatives, positively affecting net margins and earnings.
  
• The expansion into new markets, such as the acquisition of a connected enterprise data center campus in London, coupled with innovations like HD Colo 2.0, positions the company to capture additional growth opportunities, enhancing revenue and earnings from new and existing customers.
  
• The company's focus on sustainability and the development of data centers that can accommodate AI and other high-density computing workloads addresses growing market demand, potentially driving future revenue growth and improving competitive positioning.

Assumptions

• Analysts are assuming Digital Realty Trust's revenue will grow by 9.8% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 20.2% today to 9.5% in 3 years time.
• Analysts expect earnings to reach $675.0 million (and earnings per share of $2.17) by about October 2027, down from $1.1 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $910.5 million in earnings, and the most bearish expecting $398 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 87.3x on those 2027 earnings, up from 48.7x today. This future PE is greater than the current PE for the US Specialized REITs industry at 29.2x.
• Analysts expect the number of shares outstanding to decline by 2.29% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 6.18%, as per the Simply Wall St company report.

Risks

• The increasing competition in the data center market could put pressure on the company's ability to grow its market share and maintain high leasing rates, potentially impacting revenue and net margins.
  
• Regulatory and environmental challenges associated with the high energy consumption of data centers could lead to increased operational costs or necessitate significant investment in sustainability initiatives, affecting net margins.
  
• Technological advances and the shift towards more energy-efficient or decentralized computing solutions, such as edge computing, may reduce demand for traditional data center capacity, impacting revenue growth.
  
• The company's significant investment in developing hyperscale data centers and its strategy of leasing large capacity blocks to a few clients could expose it to higher risk if these clients' demand wanes or if there are shifts in technology that reduce the need for such large-scale infrastructure, impacting earnings.
  
• Exchange rate fluctuations and the global nature of Digital Realty's operations could lead to financial volatility, impacting earnings, especially as a significant portion of the company's debt is non-U.S. dollar denominated.

Valuation

• The analysts have a consensus price target of $158.27 for Digital Realty Trust based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $188.0, and the most bearish reporting a price target of just $114.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $7.1 billion, earnings will come to $675.0 million, and it would be trading on a PE ratio of 87.3x, assuming you use a discount rate of 6.2%.
• Given the current share price of $161.21, the analyst's price target of $158.27 is 1.9% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.