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Digital Realty Is No Dinosaur

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I’ve been covering Digital Realty (DLR) a few years (see Digital Space: A Bold New Frontier For Investing In REITs) and during that time, I have witnessed the transformation of the world’s largest data center REIT. Some early critics argued that Digital was not going to be able to compete with the biggest data providers like Facebook, Google  and Yahoo .

Although the Internet has created a boom for steady and growing cloud space the detractors argue that Digital’s wide moat is shrinking , not growing. More recently, UBS issued a SELL, downgrading shares in the San Francisco-based REIT citing a negative impact on earnings growth and a share price valuation that doesn’t support modest growth forecasts.

Ignoring future growth for a minute, let’s take a look back at Digital’s historic progress in which over the last 10 years the company has generated annualized total returns of 22%.  This is the single best performance in the REIT universe over this time-frame, and represents over 1,400 basis points of annual out-performance relative to the RMS.

Digital has generated mid-teens compound annual growth in both dividends and funds from operations (or FFO) per share from 2005-2014.  The company has also generated positive growth in both dividends and FFO per share, every single year.

Citi Investment Research recently published a report titled, "Don't Forget about Those Dividends," and identified Digital Realty as having generated the second-highest compound annual growth in dividends per share within the REIT industry over a seven- and nine-year period. (Source: DLR Investor Presentation).

Perhaps even more important, this growth has been achieved with low volatility. Digital is one of only 10 REITs among the 140 constituents within the RMZ to have increased the dividend each and every year since 2005.

Despite this remarkable track record, Digital trades at a meaningful discount to the REIT sector average on almost any measure.

Digital’s balance sheet stacks up favorably relative to a blue-chip peer group.

As compared with most other public data storage REITs, Digital is dominant . The company has a market cap of around $9.3 billion, larger than the four smaller peers combined. Equinix (EQIX), with a market cap of $12.8 billion, converted to a REIT on January 1 and the newest (data) REIT is also Digital’s fourth largest tenant.

Digital owns 131 properties and because of its broad tenant base it has a well-diversified revenue stream. In addition, Digital’s wide reaching geographic footprint offers risk protection related to market concentration. For example, Digital has only 1.3% exposure in Houston. In Digital’s latest earnings call it announced fourth quarter 2014 FFO per share of $1.40, compared with $1.26 in fourth quarter 2013. DLR reported annual 2014 FFO of $5.04, compared with annualized 2013 FFO of $4.74. Core FFO for the year (2014) was $4.96 compared with $4.78 in 2013.

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Occupancy improved 20 basis points from 93% (in third quarter 2014) to 93.2% in fourth quarter 2014. Digital reiterated 2015 core FFO per share of $5.00 to $5.10 per share. Reflecting on Digital’s valuation today, the shares are trading at $70.72 with a P/FFO multiple of 14.3x – clearly not the bargain price of $44.15 when I picked up shares in December 2013. Some have asked if I’m cashing out my chips (my total annualized return is 45.1%).

No way. Why would I cash-in my blue chip shares of Digital Realty?  This company is no dinosaur and it certainly won't be extinct anytime soon. It has grown considerably since going public in October 2004 and the best thing is that it has aged like fine wine – getting better every year. Maybe the growth won’t be gigantic but I did not sign up for home runs, I signed up for consistent and growing dividends. Besides, my dividend yield when I purchased shares was 6.3%. Where else can I get that kind of yield on a blue-chip today? (For my fair value estimate on Digital, check out my newsletter).

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Disclosure: I own shares of Digital Realty.

Brad Thomas is editor of Forbes Real Estate Investor.

Source:s SNL Financial, FAST Graphs, and Digital Investor Presentation.