Digital Realty Trust, Inc. (NYSE:DLR) Q4 2023 Earnings Call Transcript

Digital Realty Trust, Inc. (NYSE:DLR) Q4 2023 Earnings Call Transcript February 15, 2024

Digital Realty Trust, Inc. misses on earnings expectations. Reported EPS is $0.08 EPS, expectations were $1.64. DLR isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon and welcome to the Digital Realty Fourth Quarter 2023 Earnings Call. Please note, this event is being recorded. During today’s presentation, all parties will be placed in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Callers will be limited to one question and we will aim to conclude at the bottom of the hour. I would now like to turn the call over to Jordan Sadler, Digital Realty’s Senior Vice President of Public and Private Investor Relations. Jordan, please go ahead.

Jordan Sadler: Thank you, operator, and welcome, everyone to Digital Realty’s Fourth Quarter 2023 Earnings Conference Call. Joining me on today’s call are President and CEO, Andy Power; and CFO, Matt Mercier. Chief Investment Officer, Greg Wright; Chief Technology Officer, Chris Sharp; and Chief Revenue Officer, Colin McLean, are also on the call and will be available for Q&A. Management will be making forward-looking statements, including guidance and underlying assumptions on today’s call. Forward-looking statements are based on expectations that involve risks and uncertainties that could cause actual results to differ materially. For a further discussion of risks related to our business, see our 10-K and subsequent filings with the SEC.

This call will also contain non-GAAP financial information. Reconciliations to net income are included in the supplemental package furnished to the SEC and available on our website. Before I turn the call over to Andy, let me offer a few key takeaways from our fourth quarter and our full year. First, we are seeing a robust wave of demand across our platform, and we are optimistic about our ability to execute. Leasing in the quarter was healthy, highlighted by strong volume in the 0 to 1 megawatt plus interconnection segment, record pricing in the greater than megawatt category and the second highest quarter ever of new logos added. Second, our fundamental metrics capped off the year on a high note with the strongest cash re-leasing spreads and same capital cash NOI growth we’ve seen in years as our unique and differentiated value proposition continued to resonate.

And lastly, in the fourth quarter alone, we announced nearly $8 billion of new development joint ventures and completed over $1 billion of equity issuance under our ATM bringing total capital sources raised during the year to more than $12 billion and reducing pro forma leverage below our year-end 2023 target. The execution on our funding and capital plan in 2023 has positioned Digital Realty to be able to support our customers’ data center infrastructure needs as the next generation technology unfolds. With that, I’d like to turn the call over to our President and CEO, Andy Power.

Andrew Power: Thanks, Jordan, and thanks to everyone for joining our call. 2023 was a milestone year for Digital Realty, as we made strong progress toward our strategic objectives despite significant volatility in financial conditions and broader uncertainty around the world. For me, 2023 will be revered as the year of AI’s arrival to the data center forefront, ushering in an unprecedented new wave of data center demand, driving a step function of change across the industry’s landscape. The year that Digital Realty enhanced its customer value proposition by adding connectivity-rich solutions while also scaling our capacity for hyperscale and AI workloads. We expanded our footprint with new connectivity-oriented locations around the Mediterranean and elsewhere.

Enhanced our joint venture in India with the addition of Reliance Jio and increased the number of direct access points on our campuses to the leading cloud and service providers. We accelerated the growth of service fabric with more than 70 discrete services added to the platform and over 100 unique services available by year-end and enhance its capabilities with new composes like service directory. We also added 9,000 new cross connects in the year, indicative of our growing connected data communities. 2023 was a year that we integrated and innovated at a faster pace than ever before. We strengthened our leadership team and aligned our platform to three regions to be consistently structured around the world. We adapted our product portfolio to meet market demand, evolving our offering to efficiently support next-generation chips like the NVIDIA H-100 in numerous data centers.

Our high-density colo capability deployed across 32 markets spending all three regions is equipped to handle three times the H-100 requirements. And we continue to add green energy solutions to power many of these power dense applications. Like our large solar PPA in Germany and our agreement supporting 100% renewable power in Texas, San Francisco, New Jersey and Sydney. And 2023 was the year that Digital Realty took decisive action to strengthen our balance sheet by developing a portfolio of private capital partnerships and vehicles that diversified our capital sources while enabling us to support our customers’ fast-growing requirements. And we did all of that while continuing to provide the operational excellence that is expected of a global data center leader and that our customers rightfully demand.

On this call a year ago, I outlined a plan to bolster and diversify our capital sources. Our goals were to reduce our leverage towards six times by the end of the year. Increase our liquidity to fund our development program and diversify our capital sources to limit our reliance on the capital markets, increasing our ability to meet the accelerating demand for data center capacity and to enhance our returns on invested capital. We outperformed on each of these goals, sourcing over $12 billion of new capital and commitments for new investment and debt repayment, reducing pro forma leverage to just 5.8 times when adjusted for transactions that have been announced or closed since year-end. We also ended the year with five new JV partners and expanded some of our existing relationships.

To round out the year, we announced three significant transactions in the fourth quarter, including two development joint ventures and the successful resolution to our relationship with Cyxtera, we also raised $1.2 billion of equity under our ATM since the end of September. I will quickly run through the highlights of these transactions. In early January, Greg completed his famed Triple Lindy with the Cyxtera transaction by selling $275 million of assets to Brookfield along with the purchase of Cyxtera’s leasehold positions in Singapore and Frankfurt for $55 million, yielding net cash of $220 million to Digital Realty. In addition, Brookfield assumed three existing leases and amended three others in our portfolio to accelerate their expiration to the end of September 2024.

Finally, Digital Realty obtained and exercised an option to purchase a Cyxtera data center and the Slough Trading Estate adding one of London’s highly sought-after submarkets to Platform Digital’s connectivity and enterprise colo offering. This transaction remains subject to customer closing conditions and is expected to close towards the end of the first quarter. In November, Realty Income purchased an 80% interest in 400 million data centers that are under development and leased to an investment-grade financial services company. The tenant has the option to expand the facility up to an estimated potential cost of $800 million. We received $200 million upon closing and reduced our funding obligations for the remainder of this project to just 20% of the total capital, enabling us to reinvest the capital in higher-return projects.

Finally, the $7 billion development joint venture with Blackstone is our largest and most forward-looking transaction and accelerates the monetization of nearly 20% of our three-plus gigawatt land bank. This JV involves the sale of an 80% interest in nearly 500 megawatts of capacity across four campuses in Paris, Frankfurt and Northern Virginia and enables us to better support our hyperscale customers’ needs. Approximately 20% of ventures total potential data center capacity is expected to be delivered through 2025. We will retain a 20% interest in the developments and earn fees for developing, leasing, operating and managing these facilities. All told, in 2023, we announced or completed joint ventures and asset sales driving leverage down roughly 1.3 turns from the first quarter peak accelerating our ability to deliver needed capacity to our customers and enhancing our returns on invested capital.

I would also be remiss if I did not mention Digital Core REIT’s successful $120 million follow-on equity offering last week which will support the REIT’s planned acquisition of an incremental 24.9% interest in our jointly owned asset in Frankfurt for $125 million. Let’s shift to a brief recap of our results and offer some insights into the trends we are seeing across our business. I’m pleased with our results for 2023, which helped to lay the foundation for an acceleration in long-term sustainable growth in earnings and free cash flow that should take shape as we head into 2025. Our fourth quarter results were broadly consistent with the first three quarters of 2023 with continued strength in our operating performance KPIs and an incremental improvement in our financial position as we continue to execute on our value proposition with the goal to support the increased demand for data center capacity.

Leasing remained healthy, especially in our targeted 0 to 1 plus interconnection segment with 134 new logos, bringing our total new logos for 2023 to a new annual record of more than 500. Renewal spreads were strong for the fifth consecutive quarter, remaining positive across product types and regions. Same capital cash NOI growth continue to demonstrate the underlying strength of our business with 9.9% year-over-year growth in the quarter. And churn remained low and well controlled at 1%, while occupancy was impacted by the delivery of significant vacant development capacity. The combination of cloud and AI is driving unprecedented demand for scale and hyperscale capacity alongside the steady enterprise and connectivity-oriented demand we’re experiencing within our 0 to 1 megawatt plus interconnection segment.

Supply constraints driven by limited availability of power and global supply chain delays have continued to drive the pricing pendulum in our favor or our growing value proposition is increasing interest in our existing inventory and the new development that we have underway. Ongoing conversations with customers pretend a significant potential acceleration of leasing and development and we believe we are well positioned. The demand seems to be spilling across most markets, particularly for larger capacity blocks, though there are a few pockets of strength worth noting, including Northern Virginia, Santa Clara, New Jersey, Paris, Frankfurt, Singapore and Seoul. Our new capacity is concentrated in core markets aligned with our global meeting place strategy.

While the scale of data center infrastructure opportunities has increased alongside AI’s arrival, we remain disciplined and thoughtful prioritizing locations that enhance Platform Digital connectivity and our connected campus communities. During the fourth quarter, Digital demonstrated the benefits of collaborating with our partners with the signing of an Oracle Cloud infrastructure dedicated region deployment by a financial services customer, showcasing the potential of the collaboration between Oracle and Digital Realty to fulfill enterprise customers’ hybrid cloud requirements. Other customers are recognizing the growing value of Platform Digital’s broad and open structure. An AI service provider leveraged Platform Digital’s pre-provisioned high-density colo offering to improve their time to market in order to extend our North America and AI cloud offering that provides managed AI as a service for a global manufacturing client.

A global service provider and partner targeting enterprises and customers added more connectivity for their hybrid offerings on Platform Digital, enabling them to upgrade their IT environments to a consumption-based IT infrastructure and managed services model. A Global 2000 leader in material sciences for industrial and scientific applications needed a data center provider with global interconnectivity and access to cloud providers in Seoul and shows Platform Digital to enable them to deploy and interconnect a private AI node. A Global 50 financial services company is migrating from an on-prem data center to Platform Digital and utilizing service fabric to improve sustainability, resiliency, scalability, security and carrier diversity. And a leading Global 2000 consumer goods manufacturer grew their presence on Platform Digital by adding two additional metros to support their IT workloads and cloud connectivity.

Moving over to a quick update on our largest market, Northern Virginia. We have over 100 megawatts available for lease today in Loudon County and nearly 200 megawatts of capacity available for lease in Manassas. We are currently in active negotiations with a handful of customers for substantially all of our capacity in Loudon, though in contrast with the rumor mill, nothing has been finalized just yet. Beyond this capacity, we have another 900 megawatts of buildable capacity at DigitalDose, which we are cautiously optimistic will gain access to power in 2026 and beyond. We also expect to benefit from the active and ongoing management of our existing 500-megawatt portfolio in this market over time. Before turning it over to Matt, I’d like to touch on our ESG progress during the fourth quarter.

We continue to be recognized for our strong ESG performance in the fourth quarter and in 2024. We placed second on Sustainability Magazine’s List of top 10 sustainable data center providers. We improved to number eight on the US EPA’s Green Power partnership National Top 100 for renewable energy use and we were named as a top rated regional performer in North America by a leading global ESG ratings provider. We remain committed to minimizing Digital Realty’s impact on the environment while delivering sustainable growth for all of our stakeholders. With that, I’m pleased to turn over the call to our CFO, Matt Mercier.

Matthew Mercier: Thank you, Andy. Let me jump right into our fourth quarter results. We signed a total of $110 million of new leases in the fourth quarter with $53 million of 0 to 1 megawatt plus interconnection leasing, led by strength in the EMEA region. Interconnection bookings rebounded sequentially to $13.5 million, and we finished the year with 220,000 cross-connects despite continued network grooming. Turning to our backlog slide. The current backlog of signed by [Technical Difficulty] commenced leases increased to a new record of $495 million at quarter end as new leasing outran $84 million of commencements in the quarter. We expect commencements to pick up as nearly two-thirds of the backlog is scheduled to commence in 2024, with the majority coming in the second half of the year.

During the fourth quarter, we signed $210 million of renewal leases with pricing increases of 8.2% on a cash basis, setting the high watermark for the year, though this was skewed over 100 basis points by shorter-term renewals in one market. For the full year, cash renewal spreads were up 6.8% and or 5.5% when normalizing for short-term extensions. Re-leasing spreads were positive across product, market and region in 2023, setting the foundation for an acceleration in long-term sustainable growth. In 2024, we expect the pricing environment to remain firm and renewal spreads to remain positive, principally reflecting the near 80% weighting of lease expirations in the 0 to 1 megawatt segment. In terms of earnings growth, we reported fourth quarter Core FFO of $1.63 per share and $6.59 for the full year within our guidance range.

Earnings reflect the continued strong organic results, together with the impact from capital recycling, deleveraging and increased development spending throughout the year, as discussed on our third quarter call. Total revenue was up 11% year-over-year despite the incremental drag from the stabilized JV contributions and the noncore asset sales that closed in the third quarter. As we also noted last quarter, year-over-year revenue growth continued to be positively impacted by the significant volatility in utility costs and reimbursements, particularly in Europe. Energy dynamics proved to be a tailwind for our results in 2023. Assuming more normalized energy prices, we expect the related upside impact will moderate in 2024. Interconnection revenue was $106 million, up 9% year-over-year, reflecting continued unit growth and price increases.

Moving over to the expense side. Utilities were 5% lower sequentially, reflecting the joint venture contributions over the summer, combined with seasonal impacts. Operating expenses increased due to seasonally elevated maintenance spending in the fourth quarter. Property taxes fell back toward normalized levels, reflecting the onetime property tax reassessment experienced in the third quarter. Net of this movement, adjusted EBITDA increased 9% year-over-year. Improvement in our stabilized same capital operating performance continued in the fourth quarter with a year-over-year cash NOI up a strong 9.9% and up 7.7% on a constant currency basis. For the full year, results were also strong with cash NOI growth of 7.5% and 6.5% on a constant currency basis.

Focusing on investment activity, we spent $3 billion on development in 2023, net of the proceeds received from our first development JV closing in November, and we delivered over 230 megawatts of new capacity across the globe. Turning to the balance sheet. We continued to strengthen our balance sheet since the end of the third quarter. With the sale of $1.2 billion of equity through the ATM at an average price of $133 per share, achieving our goal of lowering our leverage towards six times and finishing the year at 6.2 times. After year-end, we made further progress on the balance sheet with the closings of the Cyxtera transactions in the first phase of the Blackstone joint venture. GI Partners also exercised their option and closed on an additional 15% share of the two stabilized assets in our Chicago JV, bringing their stake to 80%.

Pro forma for these activities, year-end leverage was 5.8 times. S&P recognized our progress in December and upgraded our outlook. Early in the fourth quarter, we paid off our $100 million Swiss Franc notes and closed the Realty Income joint venture, which generated $200 million of gross proceeds and reduced our CapEx commitments for the remainder of the project’s development. We continue to keep significant cash on the balance sheet with over $1.6 billion at year-end as we continue to prioritize liquidity and to support ongoing development spend. Moving on to our debt profile. Our weighted average debt maturity is nearly 4.5 years, and our weighted average interest rate is 2.9%. Approximately 84% of our debt is non-US dollar denominated, reflecting the growth of our global platform and our FX hedging strategy.

Approximately 85% of our net debt is fixed rate and 97% of our debt is unsecured, providing ample flexibility for capital recycling. Finally, we have less than $1 billion of debt maturing in 2024 and beyond that, our maturities remained well laddered through 2032. I’ll finish with guidance. We are providing an initial Core FFO per share guidance range for the full year 2024 of $6.60 to $6.75. Reflecting the underlying growth of our business, offset by the impact of the deleveraging activities we completed or announced in 2023. As a reminder, over the course of 2024 and 2025, we expect that our $6 billion development pipeline will become increasingly accretive as higher-yielding projects deliver. For 2024, we expect total revenue to grow by 2% and adjusted EBITDA to grow by 4% at the midpoint of our guidance ranges.

When normalizing this growth for the impact of capital recycling, total revenue and adjusted EBITDA are anticipated to grow by 7% and 10%, respectively, in 2024. We expect both our cash and GAAP re-leasing spreads, along with same capital cash NOI growth to remain solidly positive. While occupancy is expected to improve steadily throughout the year as our record backlog commences and available capacity is leased. Specifically, cash re-leasing spreads are expected to increase by 4% to 6% in 2024. Same capital cash NOI is expected to grow by 2% to 3%, and given the tougher base year comparison versus last year’s 7.5% growth and our expectations for FX and energy pricing in our colo segment. Total portfolio occupancy is expected to improve by 100 to 200 basis points by the end of 2024 while total occupancy slipped to 81.7% in the fourth quarter of 2023.

This was predominantly driven by the delivery of substantial vacant development capacity that is slated to be occupied as same capital occupancy was stable quarter-over-quarter. We also expect to continue to recycle capital in 2024 with noncore asset sales and stabilized joint ventures raising $1.25 billion at the midpoint of our guidance range. Nearly one-third of this activity was completed in early January, while the balance should close throughout this year. Along with cash on hand and retained cash flow from operations, this capital is expected to be the primary funding source of our $2 billion to $2.5 billion net development CapEx program for 2024. To be clear, this approximately 25% reduction in development spend year-over-year represents Digital Realty’s share of CapEx spend.

The total development spend on these projects will be higher when including our partners pro rata share. This concludes our prepared remarks, and now we’ll be pleased to take your questions. Operator, would you please begin the Q&A session?

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Q&A Session

Operator: We will now open up the call for questions. [Operator Instructions] The first question today comes from Michael Rollins with Citi. Please go ahead.

Michael Rollins: Thanks and good afternoon. A couple of questions. First, in terms of, you were just describing the shift in same capital cash NOI growth from 7.5% to 2% to 3%. Can you unpack more of what you’re seeing in ’24 relative to ’23? And how pricing kind of comes into the expectation for 2024?

Andrew Power: Thanks, Mike. So we’ll try to weave that into one answer, so trying to stick to one question and get through the whole roster and maybe loop back. But I’ll turn it to Matt to give you the bridge on a same-store basis.

Matthew Mercier: Sure. Thanks, Mike. So a couple of things that I would call out. First, in terms of, call it, the re-leasing spreads and their influence. First off, I think as we know, not all of our leases roll within the calendar year. So we roll roughly, call it, 20% to 25% of our portfolio in the year. And of that, 80% is in the 0 to 1 megawatt category, which is influenced by inflation or CPI, which we’ve seen come down over the course of the year, and therefore, part of the mark-to-market pricing within that segment. Then when you flip over the other 20%, which is in the greater than a megawatt category, we’re seeing in ’24 expiring rents that are higher than what we saw in ’23, which creates a tougher comp in terms of the role despite strong market rents and overall growth.

So that’s on the spread side. The other part that I would call out is in ’23, we saw benefits or tailwinds from FX as well as power pricing, which we’re not seeing in ’24, and lastly, in ’24, we are expecting higher property tax expense. So putting all those together kind of is why you’re seeing sort of the still positive, but not as positive as ’23 results for same-store portfolio in ’24.

Operator: The next question comes from David Barden with Bank of America. Please go ahead.

David Barden: Hey, guys. Thanks so much for taking the question. Maybe first, last night, we heard from one of your peers that the higher power prices in 2023 have created some sort of lagged crowding out effect in terms of budgeting and decision-making. And I was wondering if you could kind of talk a little bit about that, kind of something like maybe you’re hearing or seeing some of that in your colo business, but it wasn’t crystal. And then just as a follow-up, if I could. Matt, can you break down that $1.25 billion in kind of — or the rest of the $1.25 billion that’s closing this year? What is — how is it all breakdown and the cadence of that? Thank you.

Andrew Power: Thanks, Dave. This is Andy. I don’t think we’re experiencing the same exact dynamics on power as what you heard last night, quite honestly. I think what Matt, you just heard from Matt is the comps on a growth basis in the same-store pool are not as — we benefited in ’23 from power, and we’re not going to have that kind of benefit repeat itself in 2024, assume it and I think this all is going to be washed out once we say by the ’25, assuming we don’t go back into this another, call it, very volatile power environment. So it’s almost one-time in nature. I don’t I don’t believe that is impacted buyer behavior. And I don’t believe we’re suffering or benefiting depending on the period to the same degree of what was described.

Maybe that’s due to the market mix, overall business mix in our hedging strategy, which are not identical. I can tell you from a business standpoint, and you can see this in the results, we capped off a very strong year, let’s call it, focused on the enterprise colo connectivity segment. Record overall new logos, North of 500. Strong quarters of new signings. You had a very strong interconnection quarter, both in new signings and also a flow through the P&L, which has been accelerating and net absorption certainly in that category that was strong in the fourth quarter and through the year. So I don’t see the power flowing through. I know we’re trying to get to one question per se and then rotate back well moved there, Greg, why don’t you just touch on the components of the $1.25 billion in our guidance for data?

Gregory Wright: Sure. Thanks, Andy. Hey, David. How are you? Look, I think, again, there’s two components there. It’s really — it’s a stabilized joint ventures, and it’s our sort of noncore asset disposition. And when you look at that, call it, $1.250 billion or a range of $1 billion to $1.5 billion, call it, I think it’s important to note that over one-third of that has already been announced and is either closed or is pending close. So obviously we feel good about that number. And it’s clearly much less in the context of last year.

Operator: The next question comes from Michael Elias with TD Cowen. Please go ahead.

Michael Elias: Great. Thanks for taking the question. So Andy, we’re in the middle of one of the strongest hyperscale demand environment that we’ve seen in recent history. I was wondering, can you talk about the go-forward demand pipeline and the relative strength of the pipeline versus last year. And as part of that, can you talk about the opportunity set for the pricing for new leasing, specifically, is — do you see there being a governor on pricing given the supply-demand backdrop that we’re seeing? Thank you.