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Treasure Chest: NextDC Still Driving Growth

Treasure Chest | Oct 08 2019

FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. NextDC has defied the critics so far, with sales in excess of what can be delivered and the next two years of operating earnings growth supported by existing contracts.

-Two years of operating earnings growth supported by existing contracts at S2
-NextDC not prepared to sacrifice price for volume
-Debt position is tight but should ease over time


By Eva Brocklehurst

Data centre builder/operator NextDC ((NXT)) has been very active over the last 18 months, particularly in Sydney, with more MW (megawatt) sales contracted than can be delivered currently. Brokers expect this to underpin growth for the next few years.

Morgans points out, simplistically, NextDC needs to sell at least twice the FY19 sales rate to fill its generation 2 and generation 3 construction in under 10 years, calculating sales of around 10MW per annum are required for the next few years and accelerating towards 15MW as third-generation facilities come online.

The broker assesses M2 (Melbourne) and S3 (Sydney) are hyper-scale facilities and M3 and S2 are hybrid-scale. The former two should benefit from the rapid expansion of cloud computing and underpin a step up in growth for the company.

To date, hyper-scale demand has been limited to Sydney so the main risk relates to when demand lifts materially in Melbourne and Perth. Morgans has retracted previous concerns around the market's high expectations for sales, suspecting forecasts are now at more realistic levels.

The next two years of operating earnings (EBITDA) growth for the company are largely supported by existing contracted business at S2. There is also 10MW of contracted space in S2 which has not yet been billed but will become live over the next few years.

Citi has observed the company is very disciplined and not prepared to sacrifice price for volume. The broker has also emphasised that large-scale developments take time and investor patience should be rewarded in FY21.

That said, Citi has warned that further material contracts, particularly in Melbourne, are needed to avoid dousing investor sentiment. There is also increased potential for competition from Equinix if that company homes in on large cloud customers and wholesale deals.

Ord Minnett agrees that, while there is a surge in data usage stemming from 5G spectrum and AI (artificial intelligence), it may take longer than previously expected to build up scale. The broker maintains lingering concerns about the slow growth in M2 and B2 (Brisbane) and calculates these will take 10-11 years to fill.

At the FY19 results, UBS pointed out the construction environment has been more challenging, and S2 and the 15MW already contracted may take longer to activate. Nevertheless, the delays have little impact on the value over the life of the data centre.

Moreover, construction risk has diminished. Morgans points out the company's revolutionary continuous development methodology, which builds a vertical market on live facilities, was a world-first and significant lessons have been learned.

Assuming the assets will generate low double-digit returns, Morgans assesses there is meaningful upside over time. The main negatives include the need to improve sales in the tier 2 facilities in Melbourne and Perth as well as the balance sheet.

In terms of the latter, Morgans appreciates the company has long-term contracts that mean interest coverage increases in the outer years, as deployed capital starts to generate a return. For example, debt raised and spent in FY19-20 generates earnings in FY21-22.

The broker also remains conscious that the debt position is tight but expects this to be resolved over time. Hyper-scale contracted MW can take 2-3 years to reach full billing. The broker also emphasises the company's cost of equity remains attractive.

As the share price has weakened over the last two months the risk/reward appears more positive and Morgans takes the opportunity to upgrade to Add from Hold. FNArena's database has six Buy ratings. The consensus target is $7.81, suggesting 26.0% upside to the last share price. Targets range from $6.68 (Morgans) to $8.60 (UBS).

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