Rising interest rates have put a lot of pressure on Digital Realty (DLR 0.95%). They have made it more expensive for the data-center real estate investment trust (REIT) to borrow money, affecting its ability to finance its expansion. That has weighed on its share price, causing concerns that the company might need to cut its dividend to help fund growth. Those worries pushed its dividend yield up over 4%.
But that payout got much safer after the company secured a joint venture (JV) deal, providing it with a meaningful cash infusion. While Digital Realty still has some work to do, the company's progress on its funding plan makes a dividend cut less likely.
It's finally making some progress
Digital Realty has formed a JV with a private equity firm, GI Partners, that will own data centers in the Chicago area. The data center REIT will sell a 65% interest in two data center buildings and their associated equipment. It will receive $743 million in gross proceeds and maintain a 35% interest in the facilities it will continue to manage. Digital Realty has also given GI Partners the option to buy an interest in a third facility on the same campus.
That transaction will bring substantial cash proceeds that the company initially plans to use to pay down debt. It will help Digital Realty achieve a substantial portion of its 2023 capital plan.
That strategy initially had the company planning to bring in between $1.5 billion and $2.5 billion in proceeds from asset sales and joint ventures to help finance its planned $2.3 billion to $2.5 billion in growth capital spending to expand its data center platform.
Unfortunately, Digital Realty hadn't had much success in achieving its funding plan before securing this JV with GI Partners. It had signed a single deal to sell a noncore data center in Texas for $150 million.
Because of that, the company had to sell $1.1 billion in stock to help bridge the gap. That stock sale significantly diluted existing investors, given the decline in its share price. However, with the JV, the REIT has now raised roughly $2 billion in funding, achieving the midpoint of its target range.
In a tight spot
Digital Realty has had to turn to alternative sources of financing because higher interest rates affected its ability to secure traditional financing at attractive rates, given its stretched financial profile:
Image source: Equinix.
As that slide shows, Digital Realty generally has a much higher leverage ratio and dividend payout ratio compared to its data infrastructure REIT peers.
Rival data center REIT Equinix's (EQIX -0.91%) much lower dividend payout ratio has it on track to retain about $1.7 billion in post-dividend free cash flow this year (and that's after increasing the payment by 12% overall and 10% on a per-share basis). That's more than half the money needed to fund its roughly $3 billion capital spending plan.
Meanwhile, Equinix has substantial liquidity and a significantly lower leverage ratio. That gives it lots of flexibility to fund the difference. Digital Realty lacks flexibility because of its much higher leverage ratio.
Meanwhile, cell tower and data center REIT American Tower (AMT -0.70%) expects to produce over $4.5 billion in cash this year. That will be enough to cover its dividend outlay (about $3 billion, or enough to increase its payment by 10%) and growth capital spending ($1.5 billion). Funding growth with retained cash and selling noncore assets (it sold its Mexico Fiber business for over $250 million) will strengthen American Tower's already solid balance sheet.
The much stronger financial profiles of rivals Equinix and American Tower enabled both to continue increasing their dividends. On the other hand, Digital Realty hasn't raised its payout this year. That has it at risk of ending a streak of 17 straight years of dividend increases.
Given its tight financial profile and trouble securing alternative funding sources until recently, there were questions about whether the company could maintain its dividend, let alone continue growing it. But given the progress on its funding plan following the GI Partners joint venture, the dividend is much safer.
More progress is still needed
Digital Realty has now made meaningful progress on its 2023 capital plan. Because of that, the dividend appears to be on solid ground.
However, the data center REIT still needs to improve its balance sheet. That's why dividend investors should keep a watchful eye on its continued progress in securing deals that bring in cash to repay debt, since they will put its high-yielding payout on an even firmer foundation.
