Digital Realty Stock: Make Big Tech Pay Your Bills (NYSE:DLR)

Dividend stock investing can be a fun journey, as with every stock you buy, you are building your wealth mansion brick by brick. This is especially true when you buy quality names that contribute more and more to your everyday expenses. Every household is like a mini corporation with cash outflows and inflows and being a landlord with steady rent checks is a good path to take.

This brings me to Digital Realty Trust (NYSE:DLR), which enables everyday retail investors to be a digital landlord that leases capacity to many well-known tech names. In this article, I highlight why DLR is attractive for those who seek steady and growing income, so let’s get started.

Why DLR?

Digital Realty is the largest global provider of cloud and carrier-neutral data center, colocation, and interconnection solutions. Its international footprint spans across 290 facilities in nearly 50 metro areas across 25 countries on 6 continents. This gives DLR the benefits from the so-called “network effect”, as its size and scope enables it to offer its tenants a full array of solutions and connection needs. Its top tenants include Meta Platforms (META), Oracle (ORCL), and Microsoft (MSFT).

DLR has undergone a transformation of sorts, as prior to its acquisition of Telx 7 years ago, the vast majority (95%) of its revenue came from wholesale data centers with virtually no interconnection revenue. Today, interconnection represents 10% of revenue, as DLR moves to capitalize on increasing migration to the cloud. This is perhaps best encapsulated by what Morningstar has to say about DLR’s transition, as noted in its recent analyst report:

Digital Realty was smart to get into the more attractive co-location and interconnection business, and we think its ability to provide those services in conjunction with the capacity to offer wholesale space to the largest cloud providers leaves it well positioned to win in an evolving technological landscape, where huge cloud providers drive the industry but need to connect to virtually all other enterprises.

In Digital Realty’s data centers, tenants can directly connect to their cloud providers or other partners, resulting in reduced latency and superior security. Even when in different Digital Realty locations, customers can bypass the public internet to connect with other Digital Realty data centers via direct fiber connections within cities or through a software-defined network between cities. We expect connected data centers to become even more important with the growing reliance on multiple cloud providers and greater demand for “Internet of Things” and artificial intelligence functions.

Meanwhile, DLR continues to grow, with 3.4% YoY growth in revenue to $1.1 billion during the first quarter, driven in part by straight-line rental rates growing by 6.1%. It’s worth noting that growth would have been higher had it not been for asset disposals that caused a 4% revenue offset.

Looking forward, I would expect for revenue to tick higher in future quarters as management deploys the proceeds from the sales to towards higher yielding opportunities. This is also supported by record bookings that DLR achieved in the first quarter, driven by strong demand for its data center solutions.

Risks to DLR include increased competition from competitors such as Equinix (EQIX) and from power cost inflation in the current macroeconomic landscape. Management, however, expressed confidence in its ability to pass on these costs, as noted during the Global Communications Infrastructure Conference late last month:

Obviously, power has been a big topic of discussion of late. But with the way our contracts are structured, roughly, we’re passed through and recover directly almost 90% of our power costs from our customers from the retail, call it, a colocation or 0 to 1 megawatt category that we have.

That’s also either we have an ability to, in some cases, increase pricing as a result of increase in power costs in certain markets under certain contracts. So we have the ability to pass along some increases through that, too.

But largely speaking, we’ve been insulated from power cost increases that have been happening over the last, call it, now at this point, probably 12-plus months. So feel we’re in a pretty good position from that standpoint.

Meanwhile, DLR sports a respectable BBB rated balance sheet with a pro-forma net debt to adjusted EBITDA of 5.9x, and a strong fixed charge coverage ratio of 5.7x. Its dividend is also well-protected by a core FFO payout ratio of 67%, based on Q1 results on an annualized basis.

DLR doesn’t scream cheap at the current price of $131 with a forward P/FFO of 19.2. However, I view it as being a well-run company trading at a reasonable price, especially considering that it’s now trading well below its 52-week high of $178 achieved early this year.

Analysts expect steady FFO/share growth in the mid-single digit to low teens over the next 5 quarters and have a consensus Buy rating with an average price target of $160. This implies a potential one-year 26% total return including dividends.

Investor Takeaway

Digital Realty Trust is a high-quality data center REIT that’s trading at a reasonable price considering its growth prospects. It’s doing a good job of transitioning to the increasingly important interconnection space and should be well-insulated from cost inflation. The recent share price weakness makes DLR an attractive Buy for steady and growing long-term income.