Australia | Sep 06 2023
Analysts raise target prices for NextDC in the expectation of medium-term growth despite disappointment over FY24 earnings guidance.
-NextDC’s FY23 result meets guidance, FY24 guidance disappoints
-Capex guidance increased to fund strong surge in demand
-Large orders take time to install
-Goldman Sachs highlights company's pricing power
By Mark Woodruff
Sadly, to obtain something one often needs to relinquish something else. Operating on this theory, NextDC (NXT)) has had to sacrifice near-term earnings by cranking up its investments in order to accommodate a big surge in demand for its data centre services.
The short term set-back in growth has analysts unperturbed as their medium-term investment thesis remains intact. The average target price in the FNArena database has risen to $14.81 from $13.77 in response to last week’s FY23 results.
The CEO of Amazon Web Services (AWS) recently estimated only around 10% of enterprises have migrated to the cloud, while management at NextDC believes the Australian penetration rate is around 10-15%, with Asia tracking far lower.
So far in 2023, the company's share price has risen by 45% due to several major contract wins and AI-linked tailwinds.
The financial results for FY23 were in line with management guidance and consensus expectations, with short-term direct costs increasing by 91% year-on-year driven by significantly higher contracted energy costs.
NextDC’s customers increased in FY23 by 12.8% year-on-year to 1,820, while interconnections increased by 7% to 17,816.
FY24 guidance for underlying earnings of between $190-200m slightly missed the consensus estimate due to the material costs required to bring significant new capacity online.
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 centres over long-term contracts.
Management believes the competitive edge that sets NextDC apart includes being a Tier 4 data centre provider with a 100% uptime guarantee. Also, the company is the largest cloud on-ramp provider with a metro, regional and edge strategy.
NextDC's international plans are bigger, bolder and carry more risk than Morgan Stanley originally allowed for but should also translate into material cash flows if executed well.
The key negative surprise for the market contained within FY24 guidance, according to Macquarie, was increased facility costs as well as operating costs. Mind you, it’s felt consensus didn’t fully incorporate such an outcome into forecasts when flagged by management in May.
What did surprise Macquarie, was a slower-than-expected ramp-up of two major hyperscale customers announced in the last six months. Capex was also higher-than-expected due to both the requirement to build for major upcoming contracts as well as the overall demand outlook.
FY24 capex guidance is for -$850-900m compared to the prior consensus estimate for -$473m, with management "expecting another record year of new contract wins in FY24".
Management also expect Australian facility costs will worsen by -$12-16m driven by increases in staffing levels and investments in land banking, in addition to -$5-7m in corporate costs with continued investment in sales, capital works and technology.
FY24 margins are expected to expand due to lower energy costs and contracted price escalation. Underlying yields grew by 3% year-on-year in FY23, highlighting to Goldman Sachs pricing power across the company’s data centres.
The company reported FY23 revenue of $362m and underlying earnings of $194m, a rise of 17% year-on-year.
UBS described the FY23 result as mixed but felt positives outweighed negatives. Strong MW contracted wins of 39MW in FY23 were noted, while FY24 already sits at 23MW.
The metric for – MW contracted but yet to bill – came in at 68MW, representing 61% of the analyst’s five-year activated MW forecast across FY24-28, and 87% of the four-year forecast.
Working off FY23 annualised revenue of $4.5m/MW, Wilsons pointed out 68MWs represents around $300m of revenue upon billing, or 83% of FY23 revenue.
Since April, NextDC has added 60MWs of contracted utilisation, equal to 41% of all contracted utilisation since the company was founded in 2010.
Morgans noted orders of this magnitude take time to physically install so don’t materially move the dial on revenue until FY25.
The chances of a capital raise
Gearing declined to 20% in FY23 from 25% in FY22 which reflected an equity raise.
With around $2.3bn of liquidity in cash and undrawn facilities, Citi observed the company has ample funds to invest for growth over the next three years, but also noted potential for another capital raise (potentially in 2025) should next generation assets be brought forward or the fit-out for M2 and M3 needs to be sped-up.
Ord Minnett forecasts the company would use most of its liquidity before reaching free cash flow breakeven in FY30 though concedes a quicker breakeven is possible should the company not grow quite as quickly.
Outlook
Last week, Citi noted the quantum of demand for NextDC is materially higher than originally expected, which was attributed to both industry-wide demand and a customer preference for the company’s data centres because of location and availability.
After reviewing commentary by hyperscalers during the recent US reporting season, Morgan Stanley detected a re-acceleration in cloud growth expectations.
The analysts’ earnings forecasts increased materially from FY26 onwards, as cash-flows begin to materialise, underpinning a five-year earnings compound annual growth rate (CAGR) of 25%.
This broker pointed out the company is a long duration infrastructure play for investors on the structural trend growth of both cloud and AI-linked computing power.
By aiming to expand internationally, Morgan Stanley believes management is targeting higher growth for longer, though the trade-off is extra risk.
The compelling growth profile appeals to Goldman Sachs as does the proven and profitable business model, along with what the broker sees as an unjustified growth-adjusted valuation discount relative to peers.
FNArena's daily monitoring of NextDC consists of six brokers, of which five have a Buy rating (or equivalent), while Ord Minnett stays with its Lighten recommendation as it considers shares slightly overvalued.
The $14.81 average target price of the six brokers suggests around 11.8% upside to the latest share price.
Overweight-rated Wilsons and Goldman Sachs (Buy) are not monitored daily and have an average target price of $15.50.
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