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What happened
Like many stocks in 2022, shares of data center REIT Digital Realty Trust (NYSE: DLR) fell sharply. In this case, Digital Realty’s stock peaked on Jan. 3, reaching its all-time high on the first day of trading last year. Since that peak price of just over $175 per share, Digital Realty’s stock fell below $90 per share in mid-October. And while it has recovered some, shares are around $98 at recent prices.
To put it into context, Digital Realty’s shares haven’t persistently traded at these prices since 2016:
So what
A couple of factors are at play here. First, Digital Realty’s stock price, like those of many other tech-focused companies, did get caught up in the tech/growth stock speculative bubble we saw in 2020 and 2021. While it’s a real estate company at its core — Digital Realty owns the data centers, and leases access to them to its customers — many investors saw its future prospects heavily tied to all of the changes that we lived through during the coronavirus pandemic.
More remote work, streaming of entertainment and work (think: Zoom and other remote conferencing tools), and an increasingly digitally connected world; a data center on every street corner, so to speak. Yet growth has slowed. Revenue was up 5% in the third quarter and the base rents Digital Realty charges fell on new leases it signed in the third quarter. This comes after a long streak of double-digit and high-single-digit revenue growth for the company.
As a result of slowing revenue growth and weakening margins due to rising costs and rent pressures, funds from operations, or FFO — the best measure of earnings for real estate-focused companies like Digital Realty — was roughly flat in the quarter. Business and economic conditions have steadily deteriorated this year; Digital Realty lowered its full-year FFO guidance twice during the course of 2022.
But there’s context investors need to know. Over the past few years, Digital Realty has become an increasingly international business, and for good reason. As developed data center markets become more mature, it has shifted its growth focus to international opportunities. This is a wonderful strategy and the right move for the business, but in the current macro environment, foreign exchange (read: a strong U.S. dollar) makes those international revenues less valuable. And that’s making its growth less apparent, and weighing on profitability.
Digital Realty’s constant-currency core FFO guidance makes this more apparent: Based on this measure, which adjusts out the impact of foreign exchange, Digital Realty is on track to achieve the guidance it set at the beginning of 2022.
Now what
Growth — both accounting for foreign exchange and otherwise — has slowed; that’s a fact of business for a company that’s been around for decades. It also has to deal with rising interest rates: Building data centers is expensive, Digital Realty has nearly $16 billion in debt, and it has regularly taken on more debt as it has grown its real estate footprint. This will continue going forward, as that reasonable use of debt helps leverage its returns.
Combine that with the weakening global economic environment, and 2023 could be a relatively poor year for Digital Realty — at least compared to its stellar growth over the past 15-plus years. Frankly I don’t expect Digital Realty’s stock price to surge the 78% it would take to return to the all-time high this year. It could be a number of years before a new high is attained.
But: Digital Realty looks like an absolute buy at current prices. The global technology and demographic trends make it abundantly clear that we will need a lot more data centers, and this global giant is a trusted partner with inroads in almost every developed and emerging economy on earth. It would be a mistake to ignore the favorable long-term trends because of a weak year, especially when its stock is priced so attractively.
Digital Realty’s stock price may not surge to new highs this year, but its long-term prospects are strong, and the dividend yield is near 5% at recent prices. Earning that yield should make it a lot easier to be patient while those favorable trends play out over the years to come.
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Jason Hall has positions in Digital Realty Trust and Zoom Video Communications. The Motley Fool has positions in and recommends Digital Realty Trust and Zoom Video Communications. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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