Digital Realty Trust, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018; year-over-year comparisons are with the corresponding 2017 periods. Figures below are consolidated and in U.S. dollars. Digital Realty Trust, Inc. is a REIT and operates primarily through Digital Realty Trust, L.P.
Business context
The company owns, develops and operates global data centers, colocation and interconnection facilities. At June 30, 2018, its portfolio included 198 data centers, including 18 held through unconsolidated joint ventures, and approximately 32.6 million rentable square feet. Portfolio occupancy was approximately 89.4%, excluding space under active development or held for development. The 2017 DuPont Fabros Technology (DFT) merger materially enlarged the portfolio and affects year-over-year comparisons.
Key financial metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Operating revenue | $754.9 million | $566.0 million | $1,499.3 million | $1,116.6 million |
| Operating income | $144.1 million | $130.7 million | $287.9 million | $267.9 million |
| Operating margin | 19.1% | 23.1% | 19.2% | 24.0% |
| Net income | $88.2 million | $79.6 million | $198.3 million | $164.1 million |
| Net income available to common stockholders | $65.1 million | $57.8 million | $151.4 million | $124.0 million |
| Diluted earnings per share | $0.32 | $0.36 | $0.73 | $0.77 |
| Diluted FFO per share and unit | $1.64 | $1.44 | $3.25 | $2.94 |
| Operating cash flow | Not provided separately | Not provided separately | $673.1 million | $519.3 million |
Operating margin is calculated as operating income divided by operating revenue. FFO is a supplemental REIT performance measure, not a GAAP measure, and excludes real estate depreciation and gains or losses on property sales.
- Revenue and earnings: Revenue rose 33% in Q2 and 34% in the first half, principally reflecting DFT acquisition contributions. Net income increased, but diluted EPS declined as the share count and preferred dividends were higher. Q2 operating income grew more slowly than revenue.
- Cash flow and investment: First-half operating cash flow increased $153.8 million year over year. Investing used $525.6 million, including $613.8 million of real estate improvements, partly offset by $195.4 million of net property-sale proceeds. Cash, cash equivalents and restricted cash totaled $27.0 million at period end, including $17.6 million of unrestricted cash.
- Debt and liquidity: Consolidated debt was approximately $9.17 billion. Fixed-rate debt, including swapped variable-rate debt, represented 88.1%; the effective interest rate was 3.57%, and weighted-average term to initial maturity was about 5.4 years. The company reported approximately $1.5 billion available under its $2.0 billion revolving facility and compliance with applicable debt covenants. Debt to total enterprise value was approximately 27%.
- Distributions: The annualized common dividend was $4.04 per share. First-half cash dividends and distributions totaled $673.6 million; management said operating cash flow has generally funded distributions, but borrowing may be needed in the future.
Material changes and unusual items
- DFT acquisition-related properties contributed approximately $160.9 million to Q2 revenue growth and $317.9 million to first-half revenue growth. Higher depreciation and amortization—up $120.7 million in Q2 and $239.0 million in the first half—also largely reflected DFT and development projects placed in service. Interest expense rose $21.2 million in Q2 and $42.8 million in the first half, primarily reflecting debt issued in 2017 and the new 2028 notes.
- The Operating Partnership issued $650 million of 4.45% senior notes due 2028 in June, receiving net proceeds of approximately $643.3 million. Proceeds temporarily repaid revolver borrowings and were also available for general corporate purposes.
- First-half property sales generated gross proceeds of $199.4 million and a recorded net gain of $53.7 million. The remaining four properties classified as held for sale at March 31 were sold during Q2.
- Stabilized-property revenue increased 1.5% in Q2 and 1.6% in the first half. For first-half renewals, GAAP rental rates increased 12.5% for Turn-Key Flex and 16.4% for Powered Base Building space. Management expected 2018 expiring-space rents, in aggregate, to be generally higher on a GAAP basis but slightly lower on a cash basis.
Outlook, risks and contingencies
- No full-year earnings or FFO guidance is provided in the filing. Management expected to spend approximately $0.5–$0.7 billion on development capital expenditures in the second half of 2018; this estimate could change with demand, leasing results and financing availability. Approximately 3.3 million square feet was under active development, with about $912.9 million of estimated future investment shown for construction in progress.
- Management cited strong data-center demand in most key markets but noted that unleased development inventory weighs on returns until leased. It targets debt to Adjusted EBITDA at or below 5.5x, fixed-charge coverage above 3x, and floating-rate debt below 20% of total debt.
- Key risks include changes in data-center demand, competition and supply, customer defaults or non-renewals, development cost or leasing delays, access to capital and refinancing, interest-rate and foreign-exchange movements, geographic concentration, energy costs and regulation, and successful integration of acquisitions. The company reported no legal proceeding expected to have a material adverse effect and said it was in compliance with debt covenants.
- The company adopted revenue standard Topic 606 in 2018 without a material effect. It was assessing the impact of lease standard Topic 842, effective January 1, 2019, which it expected to require recognition of lease liabilities and right-of-use assets for leases where it is a lessee.
Important facts for investors to verify
- How much reported growth reflects DFT and other acquisitions versus organic leasing, and how occupancy and returns on development space evolve.
- Whether leasing and cash rent trends support management’s outlook for expiring leases, given the difference between GAAP and cash rent changes.
- Development spending, completion and lease-up timing, and the financing required to fund planned capital expenditures and distributions.
- Debt maturity and interest-rate exposure, covenant headroom, and the effect of new lease accounting on reported assets and liabilities.
- The contribution of property-sale gains and acquisition-related amortization to reported earnings, and how those items compare with recurring operating performance and FFO.