Prospects Brighten Further For NextDC 

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Following a large contract win by NextDC, brokers see strong industry dynamics and increasing potential for further contracts.

-Citi recommends NextDC as a defensive growth play
-Management announces a large 36MW contract win
-Further wins and regional/overseas expansion expected 
-Potential supply constraints may bring forward demand
 

By Mark Woodruff 

Investors seeking a defensive growth play in a slowing macroeconomic environment need look no further than data centre developer and operator NextDC ((NXT)), according to Buy-rated Citi.

Last week, further evidence of such defensive growth was apparent when management announced a large hyperscale contract win, as part of an update on contracted utilisation.

Beginning in the second half of FY24, the contract will ramp up fairly evenly over a six-year period with around 6MW of billing capacity per year, explains Morgans.

NextDC builds, owns and operates independent, co-location facilities for cloud service providers, enterprises and channel partners and earns revenue from the rental of racks and cages located within its data halls over long-term contracts. 

Apart from providing investors with exposure to the secular shift towards cloud computing, Citi points out potential for an additional growth-kicker from generative artificial intelligence (AI). Leading tools in this area include ChatGPT.

The cloud service provider Microsoft is the somewhat unique beneficiary of the exponential demand for ChatGPT, which runs on Microsoft’s Azure Cloud Infrastructure, explains Morgans. It’s noted Google, Alibaba Cloud and many others have similar products on the way.

Generative AI is a form of artificial intelligence in which algorithms automatically produce content in the form of text, images, audio and video.

Thankfully, human emotions are still prevailing at the brokerage houses, and NextDC’s contract win exceeded the expectations of most analysts.

The average 12-month target price for the company, derived from six brokers in the FNArena database, rose by over 10% to $13.57 from $12.58. This new target suggests around 12% upside to the latest share price

In a rare display of near unanimity, five of the six brokers have a Buy (or equivalent) rating and one has a Hold recommendation.

Outside of the database, Goldman Sachs and Wilsons are also both Buy (or equivalent) with an average target of $13.47.

Prior to the announced win, the new 80MW S3 site in Sydney was largely empty, and, according to Morgans, many investors were becoming nervous about the fill rate. 

Macquarie suggests the new contact win of around 36MW, the largest in the company’s history, helps de-risk S3 as it is now 46% contracted.

Total contracted capacity for the company now jumps to 120MW, a level which already exceeds Morgans forecast for 101MW by June 30 this year.

Based upon inventory on hand and other assumptions, this broker believes NextDC could execute another four similar sized deals.

The outlook 

Industry feedback is signalling demand in Sydney and Melbourne remains strong and UBS, like Morgans, envisages further upside from similar contract negotiations within other data centres and/or across other major hyperscaler customers.

This broker reduces its weighted average cost of capital (WACC) assumption for NextDC to 7.0% from 7.3%, given the material size of the contract announcement and associated de-risking event.

Moreover, Wilsons believes there is now a greater likelihood of further material contract wins for the company given the explicit validation the new announcement brings. The broker also points out demand suffered in 2021 and 2022 due to a pandemic induced pull-forward of demand in 2020, and the second half of FY23 and FY24 should see further contract wins as customer ordering patterns have begun to normalise.

In addition, Citi suggests other hyperscalers may bring forward their requirements to lock-in available capacity, based upon NextDC’s new contract length of five to six years. As typical contracts are for a two to three year term, it’s thought there may be customer anxiety about potential supply constraints. 

Details around expansion into Asia are also expected in the second half of FY23, notes UBS, which together with the M4/S4/S5 data centres and regional and edge data centre opportunities will create further diversity for future earnings.

Is a capital raising on the cards?

As the company has purchased land for S5 and M5, and is also looking to expand overseas, Citi explores whether additional equity is required.

Given the new contract, the analysts expect management will accelerate development of S5, though construction is expected to take at least 12 months to start.

Based on the broker’s current capex forecasts, it’s felt NextDC does not require additional equity, yet there is a chance the equity market may be tapped, especially if there is another large contract win and development of the next generation assets needs to be brought forward.

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