The Dividend Aristocrats are considered by many dividend growth investors to be the bluest of blue-chip names. These companies have provided at least 25 consecutive years of dividend growth for shareholders, something just 65 companies in the S&P 500 Index can claim.
This is an impressive feat given that it takes a strong business model and the ability to overcome recessions to achieve.
There are names not yet among the Dividend Aristocrats that I believe will one day join this exclusive index.
We will examine why Digital Realty Trust Inc. (DLR, Financial) will likely take its place among the Dividend Aristocrats by the end of this decade.
Company background and recent results
Digital Realty is a real estate investment trust that owns, purchases, develops and manages technology-related properties.. These properties include internet gateways, data centers and technology facilities. The trust is valued at $45 billion and generates annual revenue of $3.9 billion.
It is the seventh-largest publicly traded REIT in the U.S. No peer can match the trust in terms of data center space around the world. Digital Realty has more than 174,000 cross-connections and more than 4,000 customers, demonstrating its broad appeal.
Digital Realty reported third-quarter results at the end of October. Revenue grew 3.7% sequentially, but almost 11% from the same period of 2020. Funds from operations of $479 million, or $1.65 per share, compared favorably to FFO of $432 million, or $1.54 per share, in the prior-year quarter.
New lease agreements signed during the quarter added an annualized $223 million in rental revenue. The weighted average remaining lease term was five years.
The trust increased its guidance for the year. Leadership now expects FFO of $6.50 to $6.55 for 2021, up from a range of $6.45 to $6.50 previously. Revenue is projected in the range of $4.4 billion to $4.425 billion, compared to $4.325 billion to $4.425 billion previously. The occupancy rate is expected to be close to 85% for the year.
Catalysts for future growth
Digital Realty’s FFO per share has a compound annual growth rate of close to 5% over the last decade. However, this growth rate doesn’t do the trust justice as the share count has almost tripled over this period of time. FFO increased from $430 million in 2011 to $1.74 billion in 2020, which equates to a CAGR of 17% for the decade.
Digital Realty has been able to accomplish this level of growth due to a number of factors, all of which are still present today.
First, Digital Realty has made several strategic acquisitions that have expanded its reach. Where the trust used to be just a wholesale provider of data centers, it has now added more colocation properties. Colocation simply means that a customer leases a certain amount of space within the data center instead of the entire property.
This has allowed Digital Realty to customize its properties more to the needs of clients. It has also increased the size of the trust’s potential customer pool as smaller customers now have more attraction to properties.
The trust has flexed its might in order to make large acquisitions that have instantly given it a leadership position in new markets. This will go a long way in helping Digital Realty grow its top and bottom lines.
Digital Realty enhanced its footprint in this area by acquiring Telx in 2015, which doubled the size of the trust’s retail colocation business. In 2020, the company purchased Interxion for $8.4 billion. The purchase of Interxion, which operates data centers in Europe, instantly made Digital Realty the largest colocation company in Europe.
More recently, Digital Realty announced it is purchasing Teraco, a leading carrier-neutral colocation provider in Africa, for $3.5 billion. Teraco is largest interconnected data center platform on the continent and gives Digital Realty access to an area it didn’t have before.
The trust is also a truly global entity. Close to 63% of total revenue comes from North America, but the remainder comes from the rest of the world. Continental Europe contributes 22% and the U.K. adds 7%. Every other region that the trust operates in, such as Asia, Australia and Africa, add less than 1% of total revenue. These areas are untapped sources of revenue that Digital Realty can eventually enter through acquisitions.
Customers have noticed that Digital Realty continues to position itself as a leading name in its industry, causing bookings to skyrocket.
Source: Investor Presentation
As you can see in the image above, bookings grew at a solid rate for much of the last decade, but that has increased greatly in the near term. For example, Digital Realty’s five best quarters for total bookings ever have occurred over the past six quarters.
Some of the increase in bookings is due to acquisitions in the colocation industry, but much of this is related to Digital Realty’s core business as the trust is seeing very high demand across its portfolio.
Large customers also remain a key component of Digital Realty’s business as third-quarter bookings for projects greater than 1 MW alone would have topped total bookings in nearly every other quarter since 2011. Interconnection, which was just a fraction of what the trust offered a few years ago, accounted for nearly 10% of total bookings.
As a result of all the strategic acquisitions and organic growth that the trust has experienced over the past few years, Digital Realty is now one of the largest technology-focused REITs in the world. This puts the trust is an advantageous position as customers look for the best name in the space to partner with for their business, which should allow Digital Realty to continue to grow its dividend payments to shareholders.
Dividend and valuation analysis
Following a 3.6% raise for the payment made March 31, 2021, Digital Realty’s dividend growth streak has reached 17 years. Shareholders have seen their dividend compound at a rate of just over 5% over the last decade. 2021 was the second straight year of a below-average payout ratio.
Investors typically hold shares of REITs for their high dividend yields. Digital Realty yields 3% at the moment. For context, the stock has a five- and 10-year average yield of 3.6% and 4.2%. The company is trading well below the yield for both the medium and long term. The yield does look much better when compared to the 1.3% average yield of the S&P 500 Index.
Digital Realty’s dividend looks very safe. The company distributed $4.64 of dividends per share in 2021. Using the midpoint of the trust’s estimates for the year, it has an expected FFO payout ratio of 71%. REITs often have a high payout ratio, but Digital Realty’s looks reasonable and isn’t too far off the 10-year average payout ratio of 65%.
The free cash flow payout ratio is slightly higher than normal, but still in a safe range.
The trust has distributed $1.38 billion of dividends over the last year, while free cash flow totaled $1.78 billion for a payout ratio of 78%. This is nearly in line with the three-year average free cash flow payout ratio of 75%.
The higher-than-usual payout ratio coupled with the unknown regarding Covid-19 likely led to the last two dividend increases being smaller than usual.
The trust’s debt load is very manageable, which is likely to remove one possible headwind to future dividend growth.
Source: Investor Presentation
Digital Realty does have close to $16 billion in debt, but the maturity of debt is spread out over the next decade. Less than $1 billion of debt matures annually through 2024. After that, debt maturities don’t rise above $2 billion in any year out to 2032. The trust has a weighted average maturity of more than six years and the weighted average coupon is just over 2%. The vast majority of debt is at fixed rates.
Shares trade at 23.8 times the midpoint of the trust’s guidance for 2021. The company has a long-term valuation of close to 16, so the stock is trading at a steep premium to its 10-year average valuation.
That said, Digital Realty has transformed its business over the past few years and is much more of an industry leader than it was early on in the last decade.
For this reason, intrinsic value seems a more appropriate measure of the stock’s valuation. The GF Value Line shows Digital Realty is slightly above its intrinsic value, but not unreasonably so.
With a current share price close to $155 and a GF Value of $140.81, Digital Realty has a price-to-GF Value of 1.10. Shares are rated as fairly valued by GuruFocus.
Final thoughts
Becoming a Dividend Aristocrat requires a sound business model, industry leadership and multiple catalysts for growth. Digital Realty checks all of these boxes. The trust is the largest REIT of its type and has used acquisitions to augment its business. These moves have given Digital Realty leadership positions in markets that the trust hadn’t yet entered.
Digital Realty has also been successful at growing FFO per share despite a massive increase in the share count, showing the strength of the business. At the same time, the dividend has grown at a steady rate that, if not for the pandemic, probably would have continued at a more meaningful level. I expect dividend growth will be more in line with the long-term average once the pandemic is further behind us.
Therefore, Digital Realty looks to be on track to reach Dividend Aristocrat status, suggesting income-focused investors should add this leading REIT to their watchlists.
