NextDC Fulfills Expectations, Now For M3

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NextDC has signed a second hyper-scale customer for its M2 data centre, likely to propel the company into planning for M3 ahead of previous expectations.

-Accelerates the M3 investment decision
-Hyperscale customers looking to bring capacity online earlier
-Uncontracted capacity could be taken up quickly
 

By Eva Brocklehurst

Brokers have finally received the confirmation they were looking for since the company's first half result, as NextDC ((NXT)) signs up a second hyper-scale customer for M2 (second Melbourne data centre). This should underpin medium-term growth as the 6MW contract takes M2 contracted megawatts to 13MW and the total in Melbourne to 27MW.

The announcement of 12MW of new firm capacity and a further 33MW in options has surpassed the volume Canaccord Genuity assessed would be required over the second half of 2020 and would not be surprised if there is more to come, as the recent announcements have focused on Melbourne and there is capacity available in Sydney.

The broker acknowledges, six months ago, it feared M2 was a fast depreciating asset with little hyper-scale activity in evidence. However M2 now looks to be sold out, if all options are exercised, and the focus is now on acquiring the site for M3.

For context, Morgans points out it has taken just over two years to sell the amount in M2 that it took six years to sell in M1. The broker believes the two recent contract wins validate NextDC's expenditure to date on M2 and accelerate the M3 investment decision.

Goldman Sachs cites Alibaba as an example of the heightened demand for hyperscale space, as it announced US$28m in cloud investments in April. Enterprise demand could also accelerate as businesses look to address remote "home" workplaces.

Focus On Melbourne

The company's ability to win major deals in Melbourne was a key debate amongst investors, Morgan Stanley points out. Even as activity was picking up, feedback seemed to be signalling that Melbourne did not have the same cable connectivity as Sydney. This issue has been put to rest now.

Hyperscale leads retail and Morgan Stanley suspects this may the start of an acceleration in demand for space at M2. Data centre capacity takes time to build out, the broker explains and, if demand accelerates, uncontracted capacity could be taken up quickly.

As NextDC continues to face a positive industry backdrop with hyperscale customers now looking to bring capacity online earlier because of the pandemic, Ord Minnett finds further potential for both Melbourne and Sydney as data centres reach full capacity faster.

Morgans, too, has already factored in further contract gains into FY22 estimates but is more confident now about the earnings profile. Capital expenditure forecasts are increased accordingly, and this increases depreciation and lowers earnings per share forecasts.

The broker now assesses the investment case is more compelling as it is lower risk. Management has raised FY20 capital expenditure guidance to $340-380m, as it pulls forward 3MW of capacity to accommodate the new contract.

Ord Minnett suspects it will take some time to ramp up to full usage of the initial 6MW in the new contract and also assumes the ramp up in billing a slower than previously forecast. Still, the announcement pulls forward its forecasts by 1-2 years, increasing the internal rate of return estimate for M2.

The broker is encouraged that customers are finally making a move into the all-important Melbourne market, although the use of options on additional capacity means they are not yet 100% committed.

Valuation

Canaccord Genuity believes NextDC will be a beneficiary of long-term structural trends and retains a Buy rating. The broker, not one of the seven monitored daily on the FNArena database, points out NextDC has a valuation substantially higher than international peers, but this is warranted based on the large and visible growth outlook.

The broker raises the target to $11.00, principally on a reduced risk weighting attached to M2. Ord Minnett agrees the business deserves a premium in a soft macro economic environment. The current contract underpins revenue growth estimates already factored into FY22 and FY23. The broker marginally accelerates medium-term megawatt activation but still only incorporates M2 maturity in FY27.

Goldman Sachs reiterates a Buy rating, with a $9.70 target. The broker, not one of the seven, notes a high degree of expectation regarding this announcement, which comes post a $672m equity raising in April. At least one more large contract is outstanding, possibly in Sydney, and with two months remaining in the second half there is now upside risk to forecasts for FY20.

FNArena's database has five Buy ratings and one Hold (UBS). The consensus target is $9.65, suggesting 9.4% upside to the last share price. Targets range from $8.50 (Macquarie, yet to comment on the update) to $10.70 (UBS).

See also, Melbourne The Short-Term Key To NextDC on March 2, 2020.

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