Growth Accelerates At NextDC

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Accelerating internet traffic bodes well for data centre operator NextDC. Brokers mull the outlook.

-B1 a case study for where returns can be expected for a full facility
-Strong underlying demand and well capitalised balance sheet
-Valuation susceptible to swings around bond rates
 

By Eva Brocklehurst

Accelerating internet traffic bodes well for data centre operator NextDC ((NXT)). The company posted first half results which were well ahead of broker expectations. Revenue growth of 39% was driven by strong volume growth.

The Brisbane data centre (B1) is now 94% full and Morgans believes, assuming the current strategy is maintained, more data centres will be a good development. While no pre-sales have been mentioned regarding the new facilities, the broker notes the pipeline has grown by over $100m in the last six months so there is clearly interest.

B1 is the company's first data centre, so Morgans believes this is a good case study for where returns can be expected from a full facility. The broker acknowledges the argument that this is largely retail and may not be a good indicator of the larger purpose-built retail/white space facilities.

Nevertheless, since the revenue-to-capital expenditure ratio and the cost to run a data centre are broadly similar across all facilities, the broker believes it is worthwhile to do the sums. Allocating 5% of corporate overhead costs to B1 reveals it has generated a 24-25% return on invested capital per annum for the last three half-year periods.

Morgans does point out that Perth and Canberra are pulling group returns down, and a large portion of the company's capital has not yet been turned into hard assets that are generating returns. So, while the consolidated returns on invested capital do not look so impressive, it does prove capital is being spent wisely, in the broker's opinion, and provides a forward view as business matures.

The company's strategy is clear to Moelis, with the intention to establish additional facilities and increase utilisation at an appropriate price and rate. The broker also likes the highly capable management team, strong underlying demand and the well capitalised balance sheet. The broker is confident this will become a materially larger company. Moelis, not one of the eight stockbrokers monitored daily on the FNArena database has a Buy rating and target of $4.91.

The second data centres in Melbourne and Brisbane (M2 and B2) are on track for practical completion by the end of FY17 and the second Sydney site (S2) is due in the first half of FY18, with another site under contract and awaiting development approval.

Macquarie expects development costs for M2, B2 and S2 will dampen future margin expansion over FY17 and FY18 until the new centres are up and running. That said, the broker believes the company is well-placed to capitalise on an acceleration in demand. Contracted utilisation increased 32% to 30MW while billing utilisation was up 36%. Interconnections were up 42% and these deliver not only additional high margin revenue but also expand the ecosystem and attractiveness for customers, Macquarie observes.

Issues

As the stock is considered an infrastructure investment by many, the valuation is susceptible to swings in bond rates – as higher interest rates mean the same dollar of earnings in 10 years time is worth less in today's dollars. On this basis, Morgans notes, while the company's cash flow and earnings do not swing around, its equity value does in the eyes of some investors.

As a result, rising interest rates are a risk to the share price. Faster customer demand would lead to share price appreciation because of a higher fill rate, and conversely slower demand may disappoint relative to market expectations.

Operating risks centre on the capital intensive nature of the business and the ability to access funding on an ongoing basis. The company has a balance sheet capacity to handle substantially more debt and self-fund expansion through operating cash flow from the base buildings. In this aspect, Morgans suspects that the way the board chooses to manage the split between debt, equity and cash flow, is a key swing factor.

The stock currently trades at a material discount to peers because of lower occupancy and its sub-optimal capital structure and resolving, or reducing, these issues will be key catalysts over the next 2-3 years, Credit Suisse believes. Credit Suisse is also looking for further evidence that sales and prices are holding up despite the increased competition.

FNArena's database shows six Buy recommendations. The consensus target is $4.43, signalling 20.2% upside to the last share price. Targets range from $4.10 (Deutsche Bank) to $4.80 (UBS).
 

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