Why QTS Realty Is Trading At All-Time Highs

Real Estate

In a nutshell, QTS Realty kicked off data center REIT earnings last week hitting on all cylinders and raising FY 2020 Guidance across the board, including revenue, adjusted EBITDA, operating FFO per share, and boosting capex to record levels.

In a Covid-19 world, many REIT asset classes have suffered and withdrawn guidance and/or cut dividends as tenants across non-essential industries have struggled to pay rent. On the other hand, secular trends such as ecommerce, work from home, and remote learning, have created opportunities in fiber infrastructure, cell towers, and data centers.

In fact, the Covid-19 pandemic has also accelerated the digital transformation by traditional Enterprise and SMB firms away from isolated on-premises data centers to distributed multi-cloud and hybrid IT architectures to deploy applications closer to customers, vendors, and employees.  

QTS Q2 2020 Highlights

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·        Reported Operating FFO (OFFO) per fully diluted share of $0.70 for the quarter, an increase of 8.5% compared to OFFO per fully diluted share of $0.65 in the same period of 2019.

·        Signed new and modified renewal leases during the second quarter of 2020 aggregating to $21.0 million of incremental annualized rent, net of downgrades.

·        Reported a Company record high annualized booked-not-billed monthly recurring revenue (MRR) balance of $111.2 million as of June 30, 2020 compared to $100.9 million as of March 31, 2020.

·        Adjusted EBIDA margins increased 310 basis points year-over-year to a record 55.3%.

·        Interconnection revenue for cross-connects increased by 30% year-over-year.

·        Churn was just 1.1% YTD, and FY 2020 Guidance was reduced to 3% to 5%, with the lower range likely in play.

QTS Boosts FY 2020 Guidance

The strong bookings during the past three quarters, along with visibility into the sales funnel and deal pipeline has resulted in an acceleration of development Capex. (QTS has increased the amount of capacity expected to be delivered and in-service in 2020 by more than 100,000 square feet of raised floor, relative to expectations at the beginning of 2020).

Notably, the 60MW of expansion space to be delivered by year-end 2020 is greater than the number of megawatts delivered during 2017, 2018 and 2019, combined!

Over 75% of this growth Capex is pre-leased, and development pipeline is fully funded through mid-2021 with $591 million of forward equity offerings. Additionally, this capital allocation as directly tied to QTS’ goal of achieving consistent growth in OFFO per share of between 5% – 9% annually to support growing the dividend in a 6%-7% range.

QTS Realty’s Digital “Secret Sauce”

QTS Realty has invested for over four years in its SDP (software defined data center) initiative. Prior to Covid-19, QTS management credited the company’s Service Delivery Platform with driving strong business momentum and efficiencies last year.

Back in February — prior to the Covid-19 nightmare becoming a daily reality – QTS CFO Jeff Berson shared in an interview with Data Center Knowledge: “We are seeing tremendous value stemming from SDP in a number of areas, including supporting a successful [customer] win-rate that is increasing our market share at strong and sustainable pricing levels.”

SDP is a game changer because it allows customers to monitor all IT deployments remotely from a mobile device and drill down to the server level in a rack to monitor every data point a technician would normally access in person.

Customers can also self-provision many new deployments without the need of a sales engineer, or alternatively work with a sales engineer “on the same page” remotely. In a similar fashion, the QTS sales team can give virtual tours to potential customers located anywhere across the globe – a huge advantage during a pandemic.

CEO Chad Williams confirmed on the Q2 earnings call that SDP differentiates every conversation for the sales team and clearly has increased the win rate when competing for Enterprise multi-cloud and hybrid IT colocation deals.

Making a Federal Case

Success in the Federal government leasing vertical appears to have finally become “a thing” for QTS Realty, (an overnight success after eight-years of pursuing this elusive market segment).

While the federal government is notoriously slow in decision making, there are a limited number of landlords and facilities that can make the short-list due to the cost and time required to run the gauntlet to become certified as an approved vendor.

There is an alphabet soup of critical designations including FedRAMP and FISMA required to provide physical data center space for federal agencies such as the Department of Homeland Security, and Department of Defense.

One reward for this effort is government contractor and Federal agency deployments can yield higher margins compared with competing on price for hyperscale deployments. QTS announced a contribution of 5MW-plus of signed government leases (across multiple locations) included in the $21 million bookings achieved during the quarter. Notably, this is an expansion of a similar 5MW-plus deal reported by QTS Realty in Q2 2019.

Investor Edge

QTS Realty continues to under-promise and over-deliver when it comes to quarterly bookings, but most of this good news is already baked into the shares.

Notably, QTS shares are trading at all-time highs, having already been bid up 35% YTD. (And per FAST Graphs, QTS shares are trading at a lofty 28.8x AFFO per share versus a “normal” multiple of just below 20x AFFO). Potential investors should consider exercising patience here and wait for a more attractive entry point.

Bill Stoller contributed to this article. I own shares in QTS.

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