NextDC On Track Despite Unpredictable Sales

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NextDC performed poorly in the wake of the first half results and several brokers believe the numbers and the company's strategy have not been well understood.

-Investor expectations need to adjust to a growth profile that remains healthy
-Melbourne the laggard in sales, needs to improve to drive re-rating
-Hyper-scale market exposes the company to buyer concentration and lower returns
 

By Eva Brocklehurst

NextDC ((NXT)) has confounded brokers over recent months after a first half result that Citi described as both "beautifully boring" and "genuinely exciting". New accounting standards muddied the waters, with the company electing not to restate comparable numbers in its first half results for FY19, but the broker assesses the company is exactly where it wants to be at this point in time, investing for further growth.

The market may have been disappointed by the disclosures associated with the results, and the stock was knocked down after only one megawatt of new capacity sales were made in the second half of FY18. The shares have performed poorly since the latest results, despite a record half of newly-contracted volumes. The company had downgraded revenue guidance for FY19, because of lower distribution and interest income as a result of the acquisition of Asia Pacific Data Centre.

Morgans suspects some investors were expecting a much larger increase in sales activity in the first half, yet customer numbers have increased 25% year-on-year and customers continue to buy increasingly more connectivity. Interconnections increased 34% and accounts for 7.7% of total recurring revenue.

Nevertheless, Morgans is conscious investors have high hopes and continues to envisage share price risk over the next few years, as expectations need to adjust to healthy growth as opposed to "hockey stick" growth.

Canaccord Genuity estimates that operating earnings (EBITDA) were up more than 25% in the first half and, thanks to a record sales period in Sydney, the company has also approached 14MW, which is 27% of its total contracted capacity. As this is not yet being billed it offers significant indications of revenue and earnings.

Assuming a lower price per megawatt for the non-billing contracted capacity, and adding $6m in annualised project revenue, the broker estimates over $217m in annual revenue is on the cards, 36% above equivalent guidance for FY19.

Canaccord Genuity suggests operating earnings have become a less useful measure of the performance of the business, with the adoption of new accounting standards that affect project revenue and rent payment.

Rather than recognising project fees upon completion, this is now amortised over the life of the contract or lease, and rent payments have been disaggregated into finance and depreciation charges. These two items, by chance, appears set to cancel each other out. In the past, project revenue was volatile and, while the new standards mean a deferred revenue liability will be recorded, it should also reduce the volatility of the profile, the broker suggests.

UBS also looks beyond the "noise", and concedes FY19 was always going to be a transition year, as the company incorporates costs associated with new data centres that should contribute from FY20. The broker is still positive about the outlook, although marginally slows its trajectory for active utilisation.

Citi agrees that FY19 is another year of investment and FY20 will be the year when it all makes sense, as the financials absorb the annualisation of higher depreciation charges. Operating leverage should emerge in FY21.

Melbourne

Melbourne continues to be the company's largest market in terms of earnings but will soon be surpassed by Sydney because of strong sales momentum in the latter. One of the issues regarding sales in Melbourne, Canaccord Genuity suspects, has been a relative lack of available inventory.

Melbourne continues to be a lag in terms of sale capacity, with only 3.4 MW secured in the last 3.5 years. By contrast, almost seven times that amount has been contracted in Sydney over the same timeframe.

Canaccord Genuity now believes, with the opening of Melbourne's second data centre (M2) in late 2017, the picture changed markedly and there is now over 40 MW available for sale in Melbourne. Still, based on the slow sales, the broker takes a cautious stance on revenue development. Macquarie asserts that weakness in Melbourne needs to improve in order to drive a re-rating of the stock.

Hyper-scale

Regardless of the headline earnings multiples, which are high, Canaccord Genuity believes there is significant scope for growth and finds it hard to believe M2 will not snare a hyper-scale contract at some point.

To Deutsche Bank, this is exactly what is at issue. The broker downgraded to Sell at the first half result, believing the increased exposure to the hyper-scale market exposes the company to a concentration of buyers and lower returns on invested capital, as well as an unpredictable sales cycle.

The broker also believes sales velocity has decreased because the more complex nature of hyper-scale contracts. Moreover, because the company is incurring significant expenditure to achieve its growth ambitions this has led to elevated debt and interest levels.

Citi asserts large-scale deployments take time and patience is required, although acknowledges any delays in asset delivery could impact the company's reputation and this poses downside risks to forecasts. There is also increased competition from Equinix, which has focus on large cloud customers.

Canaccord Genuity estimates international peers are trading on multiples of 18.1x for average June FY19 estimates. Accordingly, the broker values NextDC shares at $7.50 each, comprising $4.00 for existing operations and the balance sheet and $3.50 for the new facilities. The broker, not one of the eight monitored daily on the FNArena database, retains a Buy rating with a $7.50 target.

The database has four Buy ratings, two Hold and one Sell (Deutsche Bank). The consensus target is $7.64, suggesting 23.1% upside to the last share price. Targets range from $5.50 (Deutsche Bank) to $9.20 (Morgan Stanley).

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