“Explosive Growth: Why Data-Center Stocks Might Thrive Amid Rising Internet Demand”

In the current tech landscape, there are limited rays of hope, yet certain data-center stocks are proving resilient and may continue to shine.

“Data centers are lighthouses in the storm,” stated Nate Crossett, an analyst at Berenberg Capital Markets, in a recent report. As of March 26, data centers experienced an average decline of 7%, which stands in stark contrast to the broader real-estate investment trusts (REITs) sector, which plummeted by 32%. Fortunately, this sector has seen a slight recovery, with a handful of data centers now showing positive gains.

Leading the pack, Equinix (EQIX) has risen by 7% this year, while Digital Realty Trust (DLR) has surged by 16% following its merger with InterXion, and QTS Realty Trust (QTS) has shown a 6.9% increase. These performances significantly outperform the 19% decline registered by the S&P 500 Information Technology sector.

Data centers represent a unique blend of tech stocks and REITs, typically distributing a large portion of their earnings as dividends to achieve favorable tax treatment. These companies develop substantial, climate-controlled facilities that house essential corporate data servers and networking equipment.

These data centers lease space to major corporations such as Microsoft (MSFT), Salesforce.com (CRM), and Facebook (FB). Consequently, they stand to benefit greatly from the burgeoning digital economy, which encompasses trends like cloud computing, social media, artificial intelligence, e-commerce, and online video.

In today’s climate, it’s logical for data centers to perform well. Unlike sectors hit hard by COVID-19, such as retail malls, hotels, and senior living facilities, data centers remain insulated. In fact, with more individuals working remotely and engaging with online content, internet usage is on the rise.

Though data centers might not directly profit from these trends, their tenants certainly do. This tenant dynamic provides a layer of protection for data centers and their revenue streams amid potential economic downturns.

However, it’s essential to note that data centers won’t be entirely immune to market pressures. Plans for new or upgraded facilities could face delays owing to cutbacks in capital spending and liquidity challenges. Potential tenants may encounter difficulties acquiring hardware given ongoing supply-chain disruptions, and the overall real-estate landscape remains under significant strain.

Additionally, data centers face long-term challenges as tech giants like Facebook, Amazon.com (AMZN), and Microsoft invest in their own data centers, reducing their reliance on leasing.

Nonetheless, this segment of tech and real estate is projected to experience ongoing growth. While expansion initiatives may be postponed, rental income should persist—mainly because once enterprises have established their infrastructure in a data center, they often remain loyal tenants. Location also plays a critical role; data centers with high connectivity and proximity to population hubs enjoy superior property values and interconnection benefits for clients.

Crossett suggests three noteworthy companies: Equinix, Switch (SWCH), and QTS Realty Trust.

Equinix is predicted to achieve a 7% growth in adjusted funds from operations (AFFO) for 2020, marking one of the industry’s healthier growth forecasts. With just 2% of Equinix’s debt maturing this year and only 7% in the next three, it boasts a solid financial positioning. The company operates 200 data centers worldwide and provides co-location services to over 1,500 tenants—a model that remains unwavering.

Equinix’s stock has maintained a premium price tag due to its competitive edge and currently trades at 26 times AFFO, which is higher than the industry average of 20 times. However, the stock tends to outperform during turbulent market conditions, a trend that is evident this year as it exceeds the broader REIT sector’s performance. Crossett has set a price target of $653 for the stock, with shares recently hovering around $625.

Switch, on the other hand, presents a more speculative option in the data center sphere. This smaller company, valued at $3.5 billion, went public in 2017 and its stock currently trades below its initial offering price, partially due to concerns regarding its ambitious growth strategies that might impede shareholder returns.

Operating three data-center campuses—two in Nevada and a developing fourth in Atlanta—Switch is committed to constructing expansive “digital cities” featuring data centers exceeding one million square feet that offer a blend of storage, co-location, connectivity, and cutting-edge edge computing capabilities.

The firm benefits from an affordable energy source with its Nevada desert facilities, and its commitment to 100% renewable energy makes it appealing to socially-conscious investors. Crossett is optimistic about Switch, forecasting a remarkable 26% growth in AFFO for 2020, one of the highest rates within the industry. Despite its growth ambitions, Switch’s debt is relatively manageable, with net debt at 3.4 times earnings before interest, taxes, depreciation, and amortization (EBITDA). The company’s shift to a more shareholder-friendly share class last year alleviated previous governance concerns, perhaps making it a more attractive acquisition prospect.

Crossett has raised the price target for Switch to $16.50, an increase from the recent price around $14.40.

Lastly, QTS also showcases strong growth potential, with an expected AFFO increase of 8% this year, followed by a projected 10.1% rise in 2021. Notably, the company has minimal debt obligations due this year or the next, and it closed 2019 with a record backlog of space requests, signaling potential for growth to accelerate further.

Initially, Crossett had set a price target of $70 in late February, which has now been adjusted to $59, just above its recent trading value of $58. Nevertheless, the stock still holds promise for appreciation. “Given the leasing momentum, we believe guidance could prove to be conservative,” he noted in a recent analysis. Furthermore, QTS stands out as one of the higher-yielding data-center stocks, currently offering a yield of 3.2%.

Values are facing pressure in the current market landscape. Data centers are grappling with a persistent challenge as major firms like Facebook, Amazon.com (AMZN), and Microsoft develop their own facilities and reduce their reliance on leasing. However, this sector within tech and real estate is poised for ongoing growth. Even though expansion may experience some delays, rental income is expected to remain steady—largely because significant tenants seldom relocate after establishing their hardware in a data center. Additionally, location is critical; data centers with enhanced connectivity and proximity to population centers enjoy higher property values and offer beneficial interconnection options for tenants.

According to Crossett, three companies worth considering in this space are Equinix, Switch (SWCH), and QTS Realty.

Equinix is anticipated to achieve a 7% growth in adjusted funds from operations (AFFO) in 2020, a robust growth rate within the industry. Notably, a mere 2% of Equinix’s debt is due this year, with only 7% maturing over the next three years. As a leading player in the industry, Equinix manages 200 data centers worldwide and provides “co-location” services to over 1,500 tenants, and this situation is unlikely to change.

The stock of Equinix has consistently been valued at a premium due to its competitive edge, and it currently trades at 26 times AFFO, exceeding the industry average of 20 times. However, it is important to note that Equinix stocks tend to outperform during market volatility, and this year has been no exception, as the stock continues to exceed the broader REIT sector. Crossett has set a price target of $653 for the stock, which was recently trading around $625.

On the other hand, Switch represents a more speculative investment within the data center domain. With a market capitalization of $3.5 billion, this smaller enterprise went public in 2017, yet its stock trades below the initial offering value—partially due to concerns that its ambitious growth strategies might compromise shareholder returns.

Switch operates three data center campuses, with two situated in Nevada and a fourth one being developed in Atlanta. The company is concentrating on creating extensive “digital cities” featuring data centers exceeding one million square feet, providing a blend of storage, co-location, connectivity, and “edge” computing capabilities. Notably, two of its facilities benefit from an inexpensive energy source due to their Nevada desert locations, and the company is committed to utilizing 100% renewable energy, making it appealing to socially conscious investors.

Crossett remains optimistic about this stock, forecasting a 26% increase in AFFO in 2020, one of the industry’s highest growth forecasts. Despite its aggressive expansion plans, Switch maintains a relatively healthy debt profile, with net debt at 3.4 times earnings before interest, taxes, depreciation, and amortization. Additionally, the company restructured some of its shares into a more shareholder-friendly class late last year, possibly enhancing its attractiveness as a potential acquisition target. He has a price target of $16.50 for the stock, up from recent trading levels around $14.40.

QTS also boasts impressive growth potential, with an anticipated AFFO rise of 8% for this year and 10.1% in 2021. Crossett highlights that the company faces minimal debt obligations this year and next, and it had a record backlog of space requests at the close of 2019, suggesting that growth may accelerate further in the current year.

Crossett set a price target of $70 for QTS stock in late February, which has since been adjusted to $59—just slightly above the recent trading price of $58. Nevertheless, there is still room for growth. “Given the leasing momentum, we believe guidance could prove to be conservative,” he mentioned in a recent report. QTS is also noted for being one of the higher-yielding data center stocks, currently offering a 3.2% yield.