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Down 45% in this bear market, can Digital Realty Trust recover in 2023?


What happened

Like many stocks in 2022, data center REIT stocks Digital Real Estate Trust (DLR 3.36%) Suddenly falls. In this case, Digital Realty’s stock peaked on Jan. 3, hitting an all-time high on the first day of trading last year. Since that record price of just over $175 per share, shares of Digital Realty have fallen below $90 per share in mid-October. And while it has recovered from it, shares are sitting around $98 at recent prices.

To put this into context, shares of Digital Realty have not traded persistently at these prices since 2016:

DLR Chart

DLR data by YCharts

So what

Two factors are at play here. First, Digital Realty’s stock price, like many other tech-focused companies, got caught up in the speculative tech/growth stock bubble we saw in 2020 and 2021. being a grassroots real estate company – Digital Realty owns the data centers and leases access to them to its customers – many investors saw its future prospects strongly tied to all the changes we went through during the coronavirus pandemic.

No more remote work, streaming entertainment and work (think: Zoom and other remote conferencing tools), and an increasingly digitally connected world; a data center on every corner, so to speak. Yet growth has slowed. Revenue rose 5% in the third quarter and base rents charged by Digital Realty fell on new leases signed in the third quarter. This comes after a long streak of double-digit and high-digit revenue growth for the company.

With slowing revenue growth and weakening margins due to rising costs and pressures on rents, funds from operations or FFO – the best measure of earnings for companies focused on real estate like Digital Realty – were about flat in the quarter. Trade and economic conditions have steadily deteriorated this year; Digital Realty lowered its full-year FFO guidance twice during 2022.

But there is a background that investors should be aware of. Over the past few years, Digital Realty has become an increasingly international company, and for good reason. As developed data center markets become more mature, it has shifted its growth focus to international opportunities. It’s a wonderful strategy and the right move for the company, but in today’s macro environment, the currency (read: a strong US dollar) makes that international revenue less valuable. And that makes its growth less apparent and weighs on profitability.

Digital Realty’s constant currency base FFO forecast makes this more evident: based on this metric, which adjusts for the impact of currency, Digital Realty is on track to reach the directions it set for itself at the start of 2022.

Now what

Growth – both currency accounting and otherwise – has slow motion; it’s a business reality for a company that’s been around for decades. It also has to deal with rising interest rates: building data centers is expensive, Digital Realty has almost $16 billion in debt, and it has steadily taken on debt as it has grown its footprint. real estate. This will continue in the future, as this sensible use of debt helps leverage its returns.

Combine that with the weakening global economic environment, and 2023 could be a relatively bad year for Digital Realty – at least compared to its meteoric growth over the past 15+ years. Frankly, I don’t expect Digital Realty’s stock price to explode 78% back to its all-time high this year. It could be several years before a new high is reached.

But: Digital Realty looks like an absolute buy at current prices. Global technology and demographic trends are making it very clear that we will need many more data centers, and this global giant is a trusted partner with breakthroughs in nearly every developed and emerging economy on earth. It would be a mistake to ignore favorable long-term trends due to a weak year, especially when one’s stock is priced so attractively.

Digital Realty’s stock price may not reach new highs this year, but its long-term outlook is solid and the dividend yield is close to 5% at recent prices. Earning this return should make it easier to be patient as these favorable trends play out over the coming years.

Jason Hall holds positions at Digital Realty Trust and Zoom Video Communications. The Motley Fool fills positions and recommends Digital Realty Trust and Zoom Video Communications. The Motley Fool has a disclosure policy.



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