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Is Now the Right Time to Buy Digital Realty Trust?

Motley Fool - Fri Mar 3, 2023

Digital Realty Trust(NYSE: DLR) has made a name for itself as one of the most reliable dividend-paying real estate investment trusts (REITs). The company has raised its dividend every year since its initial public offering (IPO) in 2005. That's seventeen years of consistent dividend increases.

This impressive track record has made it an appealing buy for income investors over the years, but its latest fourth-quarter and full-year earnings for 2022 have raised concerns about the future of the company. Let's take a closer look at what's going on with Digital Realty Trust right now and if the macroeconomic pressures it's facing make it a stock to steer clear of or a bargain buy at today's pricing.

What's going on with Digital Realty Trust

Digital Realty Trust is a data center REIT that owns and leases over 300 data center facilities across the globe. Data centers help everything from streaming services, cloud-based apps, artificial intelligence, medical companies, and countless other tech-based services safely store, aggregate, and transmit digital data -- incredibly important tasks in today's tech-heavy society.

Digital Realty Trust normally reports healthy earnings with moderate but consistent year-over-year growth. Over the past ten years, its revenues, net income, and funds from operation (FFO) have grown by 216%, 20%, and 178%, respectively. But its Q4 and full-year earnings for 2022 indicate things could be changing.

DLR Net Income (Annual) Chart

DLR Net Income (Annual) data by YCharts.

Digital Realty Trust reported a net loss of $0.02 per share for Q4 compared to a net profit of $3.71 per share last year. Its diluted adjusted FFO per share (a metric that works similarly to earnings per share) also decreased by 8.5% in Q4 and fell by 4% for the full year.

Its revenues rose by 6% in the last quarter while renewing leases were up roughly 1%. So its losses aren't attributed to a sudden decrease in demand for its properties but rather are a result of greater macroeconomic issues weighing on the company. Rising interest rates have made its debt repayment more expensive; inflation is making operational expenses increase; and currency fluctuations for foreign exchange rates are eating into its earnings. And these challenges aren't subsiding.

Is Digital Realty Trust a buy right now?

The company's outlook for 2023 is pretty much flat with 2022. In my view, larger macroeconomic issues will continue to negatively impact its earnings, primarily its cost of borrowing. It has enough cash on hand to pay its debt obligations due this year, but it will need to either raise money by issuing stock (which has a dilutive effect on shareholders) or restructure its debt to pay its next major debt maturity due in 2024. These options are less than ideal in a rising interest rate environment and when the company is losing money.

The stock's debt-to-earnings before interest, taxes, depreciation, and amortization (EBITDA) ratio has also been moving in the wrong direction. Over the last year, it went from a ratio of 6.1 times to 6.9 times (for reference, the REIT average is 5 times). Its dividend payout ratio of 94.8% leaves the company with very little room to grow its dividends, but given its long history of dividend increases, I believe it will find a way to increase its payout even if it's a marginal bump.

Data center REITs normally trade at a premium. Equinix(NASDAQ: EQIX), the only other pure-play data center REIT in the public market, trades around 23 times its adjusted FFO. Digital Realty Trust is trading around 17 times its diluted FFO per share. This may look like favorable pricing, but I feel it's simply a fair adjustment for the risks the company is facing.

I've owned shares of Digital Realty Trust for a few years and don't plan to sell my shares in the stock because of its recent earnings. I do, however, plan to monitor its performance in the coming year to ensure things don't get worse for the company.

New investors who were considering buying shares in the company may want to hold off on buying Digital Realty Trust right now. Its rising debt and weakening earnings concern me, and I don't feel its pricing or 3.5% yield are juicy enough to warrant it a buy considering the headwinds it's facing.

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Liz Brumer-Smith has positions in Digital Realty Trust and Equinix. The Motley Fool has positions in and recommends Digital Realty Trust and Equinix. The Motley Fool has a disclosure policy.

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