NextDC Ramping Up Developments

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Data centre developer and operator NextDC impressed brokers with its FY16 result, revealing top line growth, margin expansion and a maiden full year profit.

-Capital intensive business so ability to access funds and utilise debt the key risk
-Outsourcing and cloud technology to increase data centre demand materially
-Company relaxed about competition and data centre supply

By Eva Brocklehurst

NextDC ((NXT))  impressed with a solid FY16 result, revealing top line growth, margin expansion and a maiden full year profit. The company is expected to deploy most of its cash balance in FY17 in the expansion of its existing footprint and the building of the new data centres in Brisbane (B2) and Melbourne (M2), which should be operational at the end of FY17.

Morgans continues to find the outlook positive with the catalysts ahead relating to the potential for large white space deals and the possibility of inclusion in the ASX200. The broker makes material changes to capital expenditure estimates, largely in relation to timing, which does not change the overall valuation materially. The shares have had a strong run, hence the broker downgrades to Hold from Add as there is now less than 10% upside to valuation.

Morgans does highlight the fact the business is capital intensive and the ability to access funds on an ongoing basis and effectively utilise debt is a key risk. That said, the broker believes NextDC has the capacity to handle more debt and self fund expansion through operating cash flow.

UBS is also confident NextDC can fund the entire roll out of the second data centres in the two capitals. A second one in Sydney (S2) is considered the next likely development. Assuming 80% of contracted capacity is the trigger, the broker estimates NextDC could acquire land in Sydney the second half of FY17 and build over FY18.

UBS does not expect increasing supply from data centres will result in price deflation over the next five years. The broker estimates that less than 20% of the required capacity has shifted to outsourced data centres and the adoption of cloud technology is likely to increase demand substantially.

Macquarie observes the results were helped by a significant lift in billing utilisation, up 66% on the prior year. Contracted utilisation sold at an average rate of $3.98m per megawatt in the second half, which represented as small decrease on the first half as billing commenced for the leading corporation and federal government contracts.

The broker anticipates the company will benefit from exponential growth in internet traffic and the trend towards outsourcing. Macquarie assumes total R&D spending between FY17 and FY23 of around $400m, including the fit-out of B2 and M2.

The discount at which the stock currently trades stems from lower occupancy, Credit Suisse notes, with a risk allowance for achieving expected returns and the business being in the throes of moving from development to infrastructure-like assets. The broker also notes the sub-optimal capital structure.

Yet, as these features are a function of the immaturity of the business, Credit Suisse expects they should be resolved in two to three years. In FY17 the broker believes the primary catalysts will be the calling of $160m in notes and reducing the cost of debt while increasing gearing.

 Deutsche Bank sticks by its Buy rating because of an improving risk profile, leverage to structural demand and the valuation. The broker notes the main downside risks include oversupply, given data centre development requires significant lead times. As a result, the signals such as returns on investment and demand for capacity are subject to change upon these centres actually reaching completion.

A loss in sales momentum is also a particularly pronounced risk for NextDC, given revenue misses meaningfully affect earnings, owing to the high operating leverage. Deutsche Bank notes the Canberra market remains soft, with the C1 contracted utilisation remaining at only 4% of total megawatts planned and 27% of built capacity, while there are early signs momentum in Perth has improved.

CLSA does not believe NextDC will need to raise equity to fund S2 now that it has generated a profit and there is little execution risk given the high operating leverage. Moreover, several funding options are available in the debt market. At worst, the company could sell its land holdings in M2 and B2 to release capital.

The broker also notes the company is relaxed about the competition created by players such as Airtrunk, founded by the former CFO of NextDC. Industry feedback suggests to the broker that operators are rational about expansion plans and oversupply is not a concern at present. CLSA, not one of the eight brokers monitored daily on the FNArena database, has a Buy rating and $4.70 target.

FNArena’s database has five Buy ratings and two Hold. The consensus target is $3.94, level pegging with the last share price. Targets range from $2.95 (Ord Minnett, yet to update on results) to $4.40 (UBS).
 

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