Favourable Winds Blow For NextDC

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The prevailing winds are blowing favourably for data centre operator NextDC as demand is robust and the company has a well-capitalised balance sheet.

-Increased confidence the company can grow hyper-scale offering without compromising returns
-Power costs a key source of risk
-Bid for Asia Pacific Data Centres still in play
 

By Eva Brocklehurst

The prevailing winds are blowing favourably for data centre operator NextDC ((NXT)) as demand is robust and the company has a well-capitalised balance sheet. Several brokers believe FY18 will be pivotal as the company is well on its way to being materially larger, and generating attractive returns on capital.

NextDC reported FY17 operating earnings (EBITDA) were up 77%. Contracted utilisation was up 21% to 31.5MW and planned capacity is upgraded by 21% to 126MW across Sydney, Melbourne and Brisbane.

No details were provided on cornerstone contracts but preferential customers will soon be moving into B2 (Brisbane's second data centre). M2 (Melbourne) is expected to open in October, while S2 (Sydney) has been delayed to the first quarter of FY19 from the first half of FY18.

UBS is impressed with the extra capacity being announced and that the new buildings are broadly on track. Moreover, fit-outs will be 10-15% cheaper and B2 will be Australia's first tier IV, five-star energy efficient certified centre, creating a serious competitive advantage. S2 and M2 are expected to achieve the same level of certification.

There is also the biggest tender pipeline the company has ever witnessed. NextDC is now moving to the next stage of its of evolution, Morgans asserts, as the more efficient second-generation data centres come on line over the next 12 months.

The broker continues to believe the stock is an attractive long-term growth story. Moelis, not one of the eight stockbrokers monitored daily on the FNArena database, agrees, upgrading to a Buy rating given the increase in planned capacity, and raising the target to $5.56 from $4.85.

Citi observes the increases in capacity are based on genuine client demand. As this is the leading indicator of revenue earnings, and ultimately profit, the broker is confident in recommending investors buy the stock in advance of the expected announcements.

While competition for large customers will probably increase in FY18, the FY17 results provide increased confidence that the company can continue to grow its hyper-scale offering without materially compromising returns.

Citi believes FY18 will be a year of investment and FY19 provide the fruits of that investment. The six months delay to S2, while disappointing, is unlikely to result in material downside. The company continues to benefit from the trend towards cloud computing, while the broker acknowledges risks include the timely delivery of assets and supply from competitors.

Macquarie agrees that keeping at the forefront of industry design standards will not only ensure competitive operating costs but help secure future work, particular from government, as customers increasingly consider the environmental impacts of their operating footprint.

Risks

Macquarie's FY18 estimates are reduced -4% , largely from rising power costs. This is the main headwind envisaged for 2018. The broker believes the company will have significant operating leverage once the individual data centres reach appropriate scale and there is a long runway for growth.

Canaccord Genuity increases revenue forecasts for FY18 by 6%, partly on the back of some power cost reductions being passed through to customers, and higher revenue assumptions. The broker, not one of the eight monitored daily on the database, retains a Buy rating and $5.05 target.

NextDC is a major user of power and direct costs, of which energy is a key component, constituted around 38% of data centre costs in FY17. Management has noted a 5% increase in power prices in FY17 and power costs have been locked in for 2018.

Morgans understands this means power costs will increase in the second half of FY18 and in the first half of FY19 before, hopefully, stabilising.

Deutsche Bank observes the implied incremental margins for FY18 are low relative to history, although this could be related to timing. The broker downgrades FY18 forecasts for operating earnings by -3%, to the mid point of guidance of $56-61m, because of the decision to lease S2 land rather than own it.

The broker notes a very bullish outlook on the near-term hyper-scale cloud negotiations. Guidance implies 36% incremental margins for FY18, attributed to ramp up and the impact of higher electricity costs.

Asia Pacific Data Centre

The unconditional takeover by NextDC has been recommended by the Asia Pacific Data Centre ((AJD)) board. The company currently holds a 21.1% stake. The bid remains in play as 360 Capital ((TGP)) is in the due diligence process, to be completed soon, and should then signal whether it wants to increase its offer price of $1.80 a share.

NextDC currently has an unconditional, all-cash bid of $1.87 for AJD. The strategic rationale for the potential takeover is to own a greater proportion of the properties in which it operates.

Morgans does not include any impact from Asia Pacific DC in its forecasts, other than the capital expenditure already outlaid to acquire the stake. The broker awaits an update in coming weeks.

The company typically runs a conservative balance sheet but, Morgans believes, it could look to top up its equity base post completion of any acquisition. The business is very capital intensive, so the ability to access funding on an ongoing basis remains the key operating risk in the broker's opinion.

There are six Buy ratings on FNArena's database. The consensus target is $5.23, suggesting 15.0% upside to the last share price. The targets range from $4.90 (Deutsche Bank) to $6.03 (Citi).
 

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