We have been waiting for almost a year to cover Equinix (EQIX).
Data center REITs have a strong correlation with tower REITs. Therefore, they tend to dive together and then recover together. This can be quite annoying since we prefer to offer more coverage on REITs that are for sale. Since EQIX would go on sale at the same time as the tower REITs, it was more difficult to get a great opportunity to open coverage on EQIX.
AFFO growth machine
The first thing to say about EQIX is that the REIT is an AFFO growth machine. It’s a more complicated REIT to analyze because the company’s AFFO metric is further away from REIT/BASE AFFO. Although REIT/BASE AFFO was below the company’s reported metric, when we assessed the NOI per share trend, the results were excellent.
How strong were the results? They were comparable to the fastest NOI (net operating income) growth machines when measured on year-over-year growth in NOI per common share since 2016. They were comparable to Rexford (REXR ), Crown Castle (CCI), American Tower (AMT) and SBA Communications (SBAC). To put that into perspective, REXR is #1 among industrial REITs on this metric.
Note: I have not yet incorporated Sun Communities (SUI) or Equity LifeStyle (ELS) into this model, although I expect them to be very high as well.
How could a REIT increase net operating income without creating shareholder value? They could do this by increasing the leverage WHERE by investing in buildings with a high capitalization rate (low quality businesses). Clearly, EQIX is not buying malls. We therefore wanted to check that their debt remained reasonable.
Did EQIX increase its leverage? No.
Their leverage has actually gone down a bit. Not noticeably lower, but it confirms that EQIX is not artificially inflating its growth rate.
Here is the historical AFFO per share (using analyst consensus estimates for the next 12 months) since 2014:
You may notice a trend in the AFFO per share. It seems to me that this line goes up as it moves to the right. Great, that’s another sign that EQIX meets our criteria for long-term investments.
It may seem that EQIX is expensive compared to some older multiples from 2014-2019, but they are cheap compared to one of the newer multiples:
Data center space can be quite competitive, but EQIX has had a lot of success. AMT’s purchase of a smaller data center REIT demonstrated extremely high confidence in the ability of data centers to generate significant cash flow growth over the next few years. We’ve covered data center basics in previous articles, so I won’t repeat those sections.
For investors who just want a general idea of data centers, we have two articles on another data center REIT, Digital Realty (NYSE: DLR)this may be useful:
If a REIT grows AFFO without increasing revenue, that raises a red flag. This isn’t necessarily a problem, but it would be worth digging much deeper into the reason. While we appreciate the efficiency improvements, it is revenue growth that demonstrates strong demand. We can see that EQIX is succeeding with dramatic revenue growth:
In addition, income is diversified around the world:
We like diversification, but we have to point out that this means that exchange rates can make many metrics look a bit lumpy.
EQIX only has a BBB credit rating, which seems a bit low for the 1.5 risk rating. However, when we look at leverage, we see a REIT that looks more comparable to a BBB+ rating. EQIX has also pushed the maturities of its debt up the yield curve. They only have a modest amount due in 2022, then nothing until 2024. They have over $2.5 billion available on a credit revolver (easy access to quick funding). That’s $2.5 billion worth of not drawn capacity. The weighted average borrowing rate on their debt is only 1.72% with a weighted average maturity of 9.3 years and 95% of the debt having fixed interest rates.
How could they get such a long term with only 1.72% borrowing rate? They’ve started borrowing in other currencies, which makes sense for a REIT with a huge global presence, but the majority of their debt is still in dollars. They have simply done a great job raising and locking up cheap debt.
We have a strong preference for REITs that don’t have to spend their FFO on recurrent capitalized expenses. EQIX does pretty well on this metric. Compared to FFOs, recurrent capitalized expenditures seem quite low. However, investors might be concerned that capitalized (non-recurring) expenses are so high. In each of the last five quarters, EQIX has spent more than $500 million in one-time capitalized expenses.
What are non-recurring capitalized expenses? It’s usually another term for development. EQIX is expanding rapidly around the world. These development projects offer an attractive return on invested capital. EQIX is keeping its dividend payout ratio extremely low in order to have more cash to develop additional projects.
Simply put, the return available on these developments is significantly higher than the return available on any other use of capital. You can see recently opened or about to open projects below:
This is a substantial volume of ongoing development. These projects are currently contributing nothing to AFFO per share, but they are driving the growth rate for years to come.
We opened coverage on EQIX yesterday and continued it by buying stocks. There is currently a strong negative trend in stock prices, but we still like the fundamentals and that’s the kind of downside we like to buy.
We felt a bit disappointed when stocks rebounded so sharply in March 2021. We wish we could have given them a chance back then. However, we have another opportunity today.