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Data is vital to businesses these days because it helps them make more informed decisions. That's why it's essential for companies to not only protect this information but also make it easily accessible. One solution that solves both problems has been to store it in data centers.
While some companies have opted to build their own data centers, many others rely on third-party owners of information technology real estate. This trend has helped power the rise of data center real estate investment trusts (REITs) like Equinix (NASDAQ: EQIX) and Iron Mountain (NYSE: IRM). That has allowed real estate investors to benefit from the sector's growth and to collect lucrative income streams in the process.
Here's a look at which of these two information storage REITs is a better buy right now.
Financial profile analysis
The first thing REIT investors should do when considering two similar investment options is to compare their financial profiles. Here's how these two data center companies stack up against each other:
|REIT||Dividend Yield||Dividend Payout Ratio||Credit Rating||Debt-to-Adjusted EBITDA|
|Iron Mountain||8.9%||75%||Ba3/BB-||5.6 times|
As that table shows, these two information storage REITs have quite different financial profiles. Equinix has stronger numbers across the board. It has a much lower dividend payout ratio, which is one factor behind its lower dividend yield. It also has an investment-grade credit profile backed by a lower leverage ratio. That investment-grade rating is worth nothing because it provides REITs with greater access to financing at lower costs.
Iron Mountain recognizes that its balance sheet is a concern. The company has a long-term target to get its leverage ratio down to between 4.5 and 5.5 times debt-to-EBITDA. That will provide it with the additional financial flexibility needed to make growth-focused investments as well as more breathing room on its debt covenants. It aims to achieve its targeted leverage ratio by holding back on growth-focused spending in the near-term and selling assets to bolster its balance sheet.
A look at what's ahead for these two data storage companies
Given its weaker balance sheet, Iron Mountain's focus this year is preservation due to the uncertainties relating to the COVID-19 outbreak. This year's goal is to maintain its dividend, manage its leverage ratio, and continue recycling capital and finding alternative funding sources.
Because of that focus, the company has deferred growth-focused capital investments and merger and acquisition (M&A) activities. Longer-term, Iron Mountain aims to have a more sustainable dividend that it can grow as its business expands. It also wants to achieve its leverage target, giving it the flexibility to invest in organic expansion opportunities and strategic M&A.
Equinix has a lot more financial flexibility to pursue growth opportunities. It views its investment-grade balance sheet as a strategic weapon that it can use to access low-cost capital to make acquisitions as well as invest in development projects. Meanwhile, its low-dividend payout ratio means it retains a meaningful amount of cash that it can also use on expansion-related investments.
The company recently used its financial flexibility to acquire 13 data centers in Canada for $750 million. The deal will provide an immediate boost to the company's funds from operations (FFO), which was already on track to climb by 11% to 16% this year. That added boost will give it even more power to grow the dividend in the future.
The value proposition
A final factor that REIT investors should consider is valuation. That's a bit tricky in this case because Iron Mountain pulled its 2020 guidance due to the uncertainties surrounding COVID-19. However, assuming it achieved its original outlook, here's how these two information storage REITs stack up:
|REIT||Recent Price||2020 FFO (Estimate)||P/FFO|
|Iron Mountain||$28||$3.28||8.4 times|
As that table shows, Iron Mountain is significantly cheaper than Equinix, assuming it delivers on its original 2020 FFO guidance, which seems unlikely. Though, even if it achieved half that forecast, it's still meaningfully cheaper than Equinix. That's largely because its weaker financial profile and near-term growth prospects are putting downward pressure on its valuation.
Higher quality is worth the premium price
Iron Mountain seems like a tempting buy since it offers investors a much higher yield and trades at a much lower valuation. However, that's due in large part to concerns about its balance sheet and growth prospects. If market conditions deteriorate, Iron Mountain might need to reduce its dividend to divert that cash toward shoring up its financial foundation.
Because of that risk, Equinix is the better buy right now, in my opinion. What it lacks in yield and value it more than makes up for in its growth prospects, which could enable it to generate higher total returns for investors in the coming years.
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