The sell-down in the REIT sector has intensified after the US Federal Reserve indicated that one more interest rate hike may be needed for the remainder of 2023.
Also, investors were spooked when the central bank hinted that rates may stay higher for longer until inflation fell back to 2%.
Keppel DC REIT (SGX: AJBU) was no exception.
The data centre REIT saw its unit price get hammered by 14.4% in just a week after it released its third quarter 2023 (3Q 2023) business update.
Income investors may be wondering if the sell-down may indicate problems with the REIT.
Let us dig deeper to find out.
Tenant trouble
Analysts had pointed out that one of Keppel DC REIT’s tenants, Neo Telemedia (HKSE: 8167), was facing financial trouble.
Neo Telemedia is the master lessee of several of the REIT’s data centres and had reported a loss of HK$123.7 million for the first half of 2023.
The Hong Kong-based data operator also had HK$842.7 million of loans coming due within a year with just HK$14 million of cash on its balance sheet.
Investors could be concerned about the potential bankruptcy of Keppel DC REIT’s tenant in its three data centres in Guangdong, China.
DBS Group (SGX: D05) released a note stating that a worst-case scenario could see 16% of Keppel DC REIT’s distribution per unit (DPU) be impacted should Neo Telemedia go bankrupt.
Although this tenant has been current with its rental payments so far, investors could be worried that Keppel DC REIT’s rental income will take a significant hit.
Higher future finance costs
Eagle-eyed investors would have spotted Keppel DC REIT’s sharp jump in finance costs for 3Q 2023.
For the quarter, interest expenses climbed nearly 57% year on year to S$43.9 million, resulting in the REIT’s distribution per unit (DPU) declining by 3.6% year on year to S$0.02492.
For the first nine months of 2023 (9M 2023), the increase in finance costs was even sharper, leaping 67.1% year on year to S$35.6 million.
Keppel DC REIT’s cost of debt has also climbed sharply in just a year.
Back in 3Q 2022, its cost of debt was just 2.3% but this has now risen to 3.5% in 12 months.
With the spectre of further interest rate increases, investors may be concerned that Keppel DC REIT’s finance costs will continue to escalate.
There is a mitigating factor, though.
The REIT requires no further refinancing for 2023 and has just 4.1% and 7% of its loans coming due in 2024 and 2025, respectively.
72% of its total debt is also hedged to fixed rates which will help to cushion against higher interest rates in the future.
Potential acquisitions
The benefit of having a strong sponsor in Keppel Corporation Limited (SGX: BN4) is the presence of a pipeline of more than S$2 billion worth of data centre assets that can be injected into Keppel DC REIT.
For its 3Q 2023 business update, the data centre REIT disclosed one additional slide showing seven of its sponsor’s data centre assets under development and management.
Analysts at the REIT’s results briefing have flagged two of these assets – Keppel DC Singapore 7 and Huailai Data Centre in Greater Beijing, as either stabilised or close to stabilisation.
This implies that these two assets could be primed for sale from the sponsor to the REIT.
Investors may be concerned about a potential equity fundraising exercise conducted at a sharp discount to the prevailing unit price.
A flurry of worries
These worries may explain the weak sentiment surrounding Keppel DC REIT.
Investors are concerned about one of its key tenant’s financial health and are also spooked by the prospect of higher finance costs led by the steady rise in global interest rates.
In addition, a potential fundraising exercise could cause an overhang on the shares if conducted at a discount to the prevailing unit price.
Keppel DC REIT’s track record, however, should provide peace of mind.
The REIT has grown from just eight assets with an asset under management (AUM) of S$1 billion during its IPO in 2014 to 23 assets worth S$3.7 billion in nine years.
Also, interest rates may not stay high for long and could be reduced should the US economy face weakness.
Neo Telemedia is also current on its rental obligations and has not indicated that it will stop its rental payments.
The potential acquisitions of two data centres should also be a net positive for Keppel DC REIT as it will boost its asset base and DPU.
All things considered, the sharp share price drop could have been triggered by this group of worries in the short term.
But over the longer term, Keppel DC REIT looks poised to do fine as the REIT manager has flagged strong data centre demand due to the rise of digitalisation and generative artificial intelligence.
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Disclosure: Royston Yang owns shares of Keppel DC REIT and DBS Group.
