Small Caps | Jul 11 2012
– NEXTDC a data centre provider
– Citi initiates coverage with a Buy rating
– Strong operating leverage an attraction
– Data market offers strong growth potential
By Chris Shaw
Data centre provider NEXTDC ((NXT)) offers space, power, cooling and security options to allow customers to both store data and operate their computing, network and IT infrastructure requirements. The company has no ties to any particular carrier.
Citi has initiated coverage on NEXTDC with a Buy rating, joining RBS Australia as the only brokers in the FNArena database to cover the small-cap stock. RBS also rates NEXTDC as a Buy.
One attraction for Citi is NEXTC offers considerable operating leverage, as once the site of a data centre has been acquired and construction is complete, operating costs are relatively modest. This means high data centre utilisation is highly profitable, Citi noting EBIT (earnings before interest and tax) margins of around 35% are the goal of management.
As well, Citi notes a number of the group's centres are scalable both within the initial floor plate releases and further expansion opportunities, which adds to growth potential as the national expansion strategy continues to be rolled out. NEXTDC currently has one operating asset but has plans for five centres in coming years.
Access to capital is a genuine barrier to entry in the data centre sector in Citi's view, especially given the scale of NEXTDC's business model. The company is near the mid-point of a medium-term capex cycle and Citi suggests funding, including sale and leasebacks, appears solid at present.
Looking forward, Citi expects the data centre model offers strong long-term growth given the continued strong growth in data usage. This reflects both the increased usage of smart phones and tablets as well the emergence of cloud computing and a shift from in-sourcing to outsourcing by a number of companies.
This supports Citi's expectations of strong earnings growth in coming years. The broker's earnings per share (EPS) forecasts stand at minus 5.5c this year, rising to 0.8c in FY13 and 3.8c in FY14 and are based on conservative sales assumptions at each data centre location. Citi's numbers assume NEXTDC reaches 58% of total capacity utilisation by FY16, which is around the time the company should enjoy strong earnings growth in the broker's view.
By way of comparison, RBS Australia has EPS forecasts for NEXTDC of minus 6.7c this year and 0.4c in FY13. One key to a potential re-rating given the time until significant earnings growth occurs is increased visibility. Citi expects the potential of NEXTDC's model will become clearer over the next 12 months, with some factors to watch for including available power load and utilisation numbers and signs clients are using multiple sites run by NEXTDC.
There are risks associated with NEXTDC's expansion plans, including delays in completing data centre projects given the potential for clients to sign elsewhere as a result and margin pressures if supply of data centre space outstrips demand. The fact NEXTDC only has one operating asset at present amplifies these risks according to Citi and sees the broker attach a High Risk assessment to its Buy rating.
On a discounted cash flow basis Citi values NEXTDC at $2.41 and sets its target at this level. This is in-line with the RBS target of $2.38 and implies upside of close to 30% relative to the current share price.
Given the magnitude of its expansion plans NEXTDC is not expected to pay dividends in the next few years, limiting returns to capital appreciation.
Shares in NEXTDC today are down slightly in a weaker overall market and as at 11.15am the stock was 2c lower at $1.87. This compares to a range over the past year of $1.345 to $2.36.
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