Is Digital Realty Trust Still a Buy After Second-Quarter Earnings?

The data center REIT handily surpassed analysts' FFO expectations and raised its guidance.

Matthew Frankel, CFP
Matthew Frankel, CFP
Jul 30, 2018 at 11:37AM

Digital Realty Trust (NYSE:DLR), a data-center real estate investment trust (REIT), reported second-quarter earnings that came in above analyst expectations. More important, they confirm that the data center market is quite strong and that the company could benefit from sustained growth for years to come.

With that in mind, here's a rundown of Digital Realty's second-quarter earnings, and why -- even though it's up by about 15% over the past three months -- it could still be a smart stock to own for the long run.

Rows of servers in a data center.

Image source: Getty Images.

The headline numbers

Digital Realty generated funds from operations (FFO) of $1.66 per share for the second quarter, five cents ahead of analysts' expectations and about 8% higher than a year ago. However, revenue of $754.9 million fell a bit short of the $760.9 million that analysts were looking for.

So, Digital Realty beat expectations on the bottom line but missed on revenue. Generally speaking, this combination doesn't translate to a big pop in the stock price. But Digital Realty is up nicely after earnings, so let's look beyond the headlines to see why.

Digging a little deeper

A closer look shows why the market is reacting so positively to Digital Realty's earnings. In a nutshell, the already-strong data center market has gotten even stronger.

Management struck a positive tone when discussing demand. As CEO A. William Stein said, "Data center demand has picked up appreciably in 2018, and we are particularly encouraged by the broad-based activity across regions as well as the depth of demand by customer vertical." 

This is certainly evident when you look at some of the market trends. In North America, where more than 80% of Digital Realty's revenue is generated, data center inventory is being absorbed by the market nearly three times as fast as it's being built. So, it's fair to say that there's already some pent-up demand for new data center properties.

Server shipments are expected to grow at a 7.5% rate this year, and with global data-center IP traffic rising at a 25% annualized rate, I wouldn't be surprised to see demand continue to grow steadily for years to come.

As a result of the higher demand, Digital Realty raised its core FFO outlook for the full year to a range of $6.55 to $6.65 per share, $0.05 higher than the previous range on both ends.

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Is it still a buy?

At 18.5 times the midpoint of its 2018 FFO guidance, Digital Realty isn't exactly cheap, but it isn't on the expensive end of the REIT valuation spectrum, either. For comparison, leading mall REIT Simon Property Group trades for 16.8 times its expected FFO, and industrial REIT giant Prologis has a P/FFO multiple of 21.8.

However, while I think those are both excellent REITs that will deliver great results over the long term, I don't think they have nearly as much growth potential as Digital Realty Trust. There's just an exploding need for data storage, and it isn't going away anytime soon.

The bottom line is that I feel Digital Realty's valuation is still quite reasonable considering the company's growth rate and the potential that remains in the data center market. I added some more shares of Digital Realty to my portfolio a few months ago, and I may consider building my position even more in the weeks and months ahead.