NextDC: More Investments, Higher Margins

This story features NEXTDC LIMITED. For more info SHARE ANALYSIS: NXT

Brokers approved of NextDC’s first-half results and management’s upgraded FY22 guidance for revenue and earnings, while increased capital-expenditure guidance is expected to result in future growth.

-NextDC’s February first-half results showed improving revenue metrics
-Rising margins were unaffected by inflation
-Six out of seven Buy ratings in the FNArena database
-Morningstar provides a note of caution

Mark Woodruff

Recent first-half results for data centre operator NextDC ((NXT)) were ahead of broker expectations. FY22 revenue and earnings guidance were also upgraded by management.

Quality management, a significant barrier to entry and an improving competitive advantage with regional/edge sites; it all appeals to Morgans. The broker sees a clear pathway for long-term growth, especially as the massive structural growth for cloud and digitisation continues.

Meanwhile, UBS was moved to say the company has multiple drivers of growth over the next 10 years and suggested shares should be considered a long-term core holding.

Ord Minnett even upgraded its rating to Buy from Accumulate and highlighted the operating leverage in the more mature data centres.

The company has nine live data centres and the S3 and M3 facilities in Sydney and Melbourne remain on track and budget. However, the broker’s target price slipped to $13.50 from $14.

Looking across all brokers in the database, target prices were massaged down by a similar percentage amount to Ord Minnett's cut, for several different reasons.

Citi and Credit Suisse were concerned by a slower ramp-up and conversion of the pipeline, while UBS cited increased land-holding and insurance costs.

Morgans also highlighted capital-expenditure (capex) guidance was increased by 8%, but overall believes this bodes well for growth, and noted the company typically builds only what it knows will be leased. This includes recently announced generation 4 and 5 sites at big-city edges and regional centres.

Data centre services revenue of $144.5m represented a beat compared to the consensus forecast of $138m, while underlying earnings (EBITDA) of $85m exceeded the $77m expected.

The first half delivered stronger margin expansion (up 420bps year-on-year) than Ord Minnett expected thanks to good cost control and low direct power costs.

The result also showed improving half-on-half revenue metrics, with revenue per square meter up 8% and revenue per megawatt (MW) up 7%. No dividend was declared (companies in the investment phase, as is NextDC, are not supposed to pay dividends but use excess cash flows to further secure future growth).

Margins

While first-half margins were better than Citi had forecast, they are expected to decline to 54% in the second half from abound 58% in the first. This is due to an estimated increase in overheads (property taxes, for example) and timing of project spend.

With NextDC expanding into new edge locations and opening its Gen 3 facilities, management has guided to an increase in fixed costs to support this growth.

Macquarie suggests less competition in regional areas will provide outlier performance. As a result, the margin performance of edge data centres is expected to raise the company-wide margin.

The expansion by NextDC into regional sites (Darwin and Adelaide have been added to Brisbane and Perth) is important for customers who want a national presence, explains the analyst.

Encouragingly for margins, management pointed to a zero short-term inflation impact. As Goldman Sachs explains, the company is fully contracted for key components of continuing builds. Also, offsetting inflation for the longer term are CPI-plus pricing contracts with power cost pass-through.  

Guidance

Data centre service revenue guidance for FY22 guidance was upgraded to $290m-295m from $285m-295m, while underlying earnings guidance rose to $163m-167m from $160m-165m.

Meanwhile, capex guidance also increased to $530m-580m from $480m-540m. Morgans attributes the increase to upgraded fit-outs for existing data centres and expenses required for the regional/edge sites.

Management noted all development activity is on budget with higher capex guidance reflecting purchases of land banks for regional expansion and a better-than-expected pipeline of developments.

Outlook

According to UBS, the completion of S3 should help NextDC win an increased share of Sydney MW's, as will M3 in Melbourne, which goes live in the first half of 2023.

Also, the smaller-scale regional/edge strategies are expected to contribute to nearer-term earnings, while S4, together with a potential expansion into Asia, provides further drivers for growth in outer years, suggests the analyst.

Citi also believes the conversion of hyper-scale customer commitments in Sydney and Melbourne will be the next key catalyst for the stock price.

Management is looking at 10 more edge sites and has acquired more land next to M2 in a bid to increase capacity.

Voice of Caution

Given Morningstar’s general focus/expertise on moats for stocks under its coverage, it’s interesting to see NextDC doesn’t qualify as having a moat, at least on Morningstar's methodology.  It’s thought the company lacks sufficient network effect and cost advantage, while switching costs are insufficient. A fair value of $11 is estimated.

While the Australian data centre industry is growing rapidly, competitors such as the world-leading co-location provider Equinix are ever present.

Nonetheless, Morningstar was impressed by the significant margin expansion in the first half and believes NextDC is set to benefit from industry megatrends.

The FNArena database has six Buy ratings and one Hold. The consensus target is $14.05, suggesting 31.9% upside to the last share price. Targets range from $11.40 (Credit Suisse) to $15.50 (Morgan Stanley).

For those brokers not updated daily in the FNArena database, Goldman Sachs retains its Buy rating and lowered its target by -1% to $14.20. Wilsons remains Overweight and lowers its target by -6.7% to $13.87 from $14.86.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

FNArena is proud about its track record and past achievements: Ten Years On

Click to view our Glossary of Financial Terms