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1 Top Stock to Buy to Cash in on This $1 Trillion Megatrend

Motley Fool - Fri Jun 30, 8:33AM CDT

Data is a hot commodity these days. Companies are using more of it as they transform their businesses to thrive in the digital economy and capitalize on emerging opportunities like artificial intelligence (AI). The rapid rise in data usage is driving the need for more infrastructure to transmit and store all this digital information.

According to one estimate, the global economy will need to invest $1 trillion over the next five years to upgrade data infrastructure. That will provide data infrastructure companies tremendous opportunities to invest capital and grow their businesses.

While many companies will benefit from this investment megatrend, data center real estate investment trust (REIT)Equinix(NASDAQ: EQIX) stands out from its REIT sector peers as the best positioned to capitalize on this opportunity. Here's why it's the top choice.

An elite financial profile

In recent years, data infrastructure investors, like data center and infrastructure REITs, have capitalized on low interest rates to fund their growth. They were able to borrow lots of money at low rates to fund acquisitions and development projects.

However, with rates rising significantly over the past year, borrowing money is a lot more expensive. Meanwhile, many data infrastructure REITs allowed their leverage ratios to rise to relatively high levels. That's now limiting their ability to borrow money to fund new investments.

While Equinix capitalized on lower rates in recent years, it didn't borrow as heavily as its peers. As a result, it has a much stronger financial profile:

A slide showing Equinix's financial profile compared to its REIT peers.

Image source: Equinix. EBITDA = earnings before interest, taxes, depreciation, and amortization.

As the slide shows, it has much lower leverage ratios than its peers. That gives it more financial flexibility to continue expanding its portfolio and dividend. On the other side, many of its rivals must de-lever their balance sheets to improve their financial flexibility.

For example, Digital Realty(NYSE: DLR) had planned to complete $1.5 billion to $2.5 billion of asset sales and joint ventures as part of its 2023 funding plan, given its elevated leverage ratio. The company recently provided an update on that funding plan, noting that it had only sold $150 million of non-core assets. As a result, it issued $1.1 billion of new equity to help bridge the gap. That was highly dilutive to existing investors, given the roughly 20% slide in its stock price over the past year.

American Tower has also focused on de-levering its balance sheet following two major debt-funded acquisitions in 2021. The company brought on a joint venture partner last year to help fund its data center business. Meanwhile, it recently sold its Mexican fiber business at a loss to help reduce leverage.

More visibility into its growth

Because it already has a strong financial profile, Equinix can focus on playing offense, while most rivals are more defensive. It's planning to invest an average of $3 billion of capital per year through 2027 to expand and maintain its data center platform. These investments should drive 8%-10% annual revenue and 7%-10% adjusted funds from operations (FFO) per share growth through 2027. That doesn't factor in any upside from future acquisitions or the potential acceleration in demand from AI.

The company has the financial flexibility to fund this growth thanks to its low leverage and dividend payout ratios. It retains significantly more post-dividend free cash than most REIT rivals. Because of that, it doesn't need to sell shares to fund new investments, which would dilute existing investors. Meanwhile, its lower leverage ratio gives it more borrowing capacity. As a result, it doesn't need to sell assets to finance new investments.

Equinix's low dividend payout ratio also drives its view that it can increase its payout by more than 10% annually through 2027. That's a lot faster than most rivals. For example, Crown Castle recently reduced its planned dividend growth rate through 2025, expecting it to be below its 7% to 8% annual target range due to higher interest rates and other headwinds.

Meanwhile, Digital Realty's streak of 17 consecutive years of growing its dividend could be in jeopardy this year if it can't complete its funding plan. It may even need to reduce its payout so that it can reduce leverage. American Tower broke its streak of consecutive quarterly dividend increases earlier this year. While American Tower still expects to deliver 10% dividend growth in 2023, the pace has slowed while it works on reducing leverage.

The top choice

Equinix's top-tier financial profile puts it in a stronger position to capitalize on the data infrastructure investment megatrend than its REIT peers. Because of that, it has much more visibility into its growth since it has the financial capacity to fund its expansion plan. That makes it stand out as the top stock to buy in the space for those seeking the highest total return potential.

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Matthew DiLallo has positions in American Tower, Crown Castle, Digital Realty Trust, and Equinix. The Motley Fool has positions in and recommends American Tower, Crown Castle, Digital Realty Trust, and Equinix. The Motley Fool has a disclosure policy.

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