Investors had a muted reaction to the third-quarter earnings report for Digital Realty Trust (DLR 0.95%). The data center company has struggled amid a sluggish economy and a slowdown in the increase in cloud spending.
Nonetheless, the stock of this data center real estate investment trust (REIT) surged higher this year, though it has closely approximated the growth of the Nasdaq Composite index. Is that a sign that investors should scale back on the stock, or has this become a value stock that investors should buy amid relatively slower growth?
DLR Total Return Level data by YCharts.
The state of Digital Realty Trust
At first glance, Digital Realty Trust may look like a slam dunk. Cloud adoption has increased at a rapid pace. Also, P&S Intelligence forecasts a compound annual growth rate of 11% for data centers through 2030, implying the world will continue to need additional facilities.
However, the industry faces significant challenges. Cloud adoption has slowed. Amazon's cloud arm Amazon Web Services (AWS), which grew net sales at 29% last year, posted just 13% in the first nine months of 2023 as clients reassess cloud spending.
Moreover, REITs like Digital Realty are highly sensitive to interest rates. This reduces the pool of potentially profitable deals. Furthermore, more companies could decide to bring the need for data centers in-house. That means its competition goes well beyond peers such as Equinix.
Digital Realty by the numbers
Amid the aforementioned conditions, Digital Realty earned $4.1 billion in revenue in the first three quarters of 2023, 19% more than during the same period in 2022.
And while a massive increase in utility expenses and a $113 million impairment charge weighed on the company, a $900 million gain on the sale of investments boosted its bottom line. That resulted in a net income for the first nine months of the year of $930 million, rising 145% from year-ago levels.
Fortunately, that left Digital Realty with $1.5 billion in core funds from operations (FFO) income for the first nine months of the year, enough to cover the dividend costs during that period.
The payout is about $4.88 per share on an annual basis, a dividend yield of around 3.8%. That is significantly higher than the 1.6% cash return from the S&P 500. With the company able to meet its dividend obligations, that trend will likely continue.
Also, Digital Realty has outperformed the S&P 500 by a wide margin. Consequently, the stock might seem expensive at a 44 price-to-earnings (P/E) ratio. However, if measured against FFO income for the last 12 months, Digital Realty sells at a price-to-FFO ratio of around 21. Such a level could inspire investors to buy if they see a cloud recovery on the horizon.
Should I buy Digital Realty?
Under current conditions, Digital Realty looks like a buy. Admittedly, a slowdown in the cloud industry and a heightened interest in maintaining clouds in-house may not bode well for the company. Additionally, higher interest rates make some property acquisitions harder to justify.
Nonetheless, assuming the data center industry can maintain an average growth of 11%, a rising tide is likely to lift all boats. At a 21 price-to-FFO ratio and a steadily rising dividend, investors could easily beat the market over time with Digital Realty stock.
