Data center REIT Digital Realty Trust (NYSE:DLR) reported its second quarter earnings on Thursday and the results look good, with the company beating expectations on both the top and bottom lines. However, the real highlight of the earnings report may not be the past performance, but rather where the company could be heading in the future.
The numbers look good, but could be even better
During the second quarter, Digital Realty generated FFO (funds from operations -- think of this as the earnings of the REIT world) of $1.26 per share, a 5% year-over-year increase. Digital Realty's core FFO (one of the most accurate measures of a REIT's profitability) of $1.30 per share looks even better -- up 7.4% from the same quarter in 2014 and significantly higher than the $1.25 analysts were expecting.
Digital Realty's $420.3 million in revenue also surpassed expectations of $410.2 million, and although the beat was mainly attributable to one-time items, such as tax reversals and asset sales, it's still a solid performance.
One important point to note is that since a significant portion of Digital Realty's revenue is derived outside of the U.S., the strong dollar has caused some foreign-exchange-related headwinds. In fact, the company says that FX is causing a roughly 300 basis point drag on its operating results. On a constant currency basis, the company's performance was even better than it appeared, with revenue up 7.8% from last year (as opposed to the reported 4.7% gain), and core FFO up by an even more impressive 11.6%.
Overall, the strength of the second quarter's results prompted Digital Realty to raise its 2015 guidance, with core FFO now expected to be in the $5.20 to $5.30 range for the full year, up slightly from the $5.18 to $5.28 range the company had been predicting.
Lots of future potential
Perhaps even more important than the numbers themselves is the future potential for growth, which the company made a point to emphasize in their earnings report and presentation. For example, Digital Realty sees massive potential to sell nonstrategic assets, find tenants for its existing inventory, and to create innovative product offerings.
Speaking of potential, the recently announced $1.886 billion acquisition of data center operator Telx has lots of it, according to Digital Realty. The companies offer complementary products (Digital Realty already owns 29% of the square footage operated by Telx), and the overlap reduces risk and creates opportunity for increased operational efficiency. Telx has grown at an even more impressive rate over the past several years than Digital Realty, with revenue nearly doubling since 2012.
CEO William A. Stein said in the company's press release that "we look forward to leveraging our combined strengths to offer the most comprehensive set of data center solutions on an open, connected, and global platform. We expect the combination of our two complementary platforms to create a powerful connection for our customers and a promising growth opportunity for our shareholders."
For example, Digital Realty claims that 15 out of Telx's 20 data centers are underutilized (which it defines as being less than 80% leased). If Digital Realty can use its resources to bring these properties up to that target, it would mean an extra $65 million in annual income, which would translate to a roughly 3.4% boost to the combined companies' revenue just by using Telx's existing assets more efficiently.
Can Digital Realty deliver on the lofty expectations?
Digital Realty has delivered exceptional performance, with an average annual total return of 18.7% over the past decade -- well above peers and the overall market.
While returns like these are unlikely (but not impossible) to be sustained year after year (especially in the current low-interest and challenging FX environment) Digital Realty is certainly taking steps to ensure that its growth continues at an above-average rate. And since shares are actually down 2.5% YTD despite the recent growth, this unique and innovative REIT may be worth a look.