NextDC ((NXT)) is racing towards critical mass in its data centres as new entrants circle the sector. Earnings growth in the short term is supported by a contracted order book, while further afield the increased supply could affect prices and demand.
The first half net loss was -$4.9m and Macquarie notes a further 10MW will begin to be billed progressively during FY20 and FY21, which along with 2-3 MW per annum of retail should make consensus estimates for operating earnings (EBITDA) in FY21 achievable.
The company has guided to operating earnings of $100-105m in FY20. Morgans assesses the core business is doing better than the headline numbers would suggest and expects NextDC will comfortably achieve guidance, noting S2 (the second Sydney data centre) is performing well and the investment case now revolves around cloud service providers coming to Melbourne.
This will enable the company to monetise its significant investment. Citi liked the margin expansion to 53% in the first half, although margins are expected to fall back to 50.2% in the second half because of expenditure on IT projects and higher energy prices. Contracted utilisation only increased slightly in the first half and there was a lack of retail inventory at S2 because of construction delays.
While bookings improved in M2, Citi notes utilisation remains low, with only 15% of bill capacity currently contracted. Still, hyper-scale activity is lumpy and the broker highlights the company is in discussions with prospective clients regarding some large opportunities. If a contract materialises that is larger than the broker anticipates this would provide upside to forecasts for M2.
In this space, NextDC has indicated the development pipeline and late-stage customer negotiations are firming up and there is high likelihood of an announcement in the next 6-12 months.
Morgans updates forecasts for FY22 to factor in more meaningful contracts, underscoring the company’s confidence that M2 and M3 will meet the forward requirements of customers and contracts should materialise shortly.
NextDC has started early works at S3 and identified a site for M3. Citi assesses there is a capacity to fund the initial development of S3 but the quantum of additional capital would depend on the pace of contracts gained in existing facilities.
S3 development could be accelerated if another major contract for S2 is awarded by the end of 2020 and S1 hit a record 99% in billed utilisation. Moreover, the company believes the industry is rational while demand remains strong across key markets.
Citi notes NextDC had $500m in liquidity available as of December 31, 2019 to support its investment program. Assuming the company spends a further $80m in the second half, liquidity is envisaged for a further fit-out of generation 2 facilities and the start of developing generation 3.
Competition
Ord Minnett suggests the results demonstrate a predictable earnings stream as well as an ability to control costs. Still, given the intense competition in the wholesale sector the broker is unsure whether the strategy to continue building hyper-scale data centres makes sense in the current environment.
Ord Minnett would prefer either the entry of hyper-scale players in Melbourne or a scaling back of the company’s ambitions for development in both Sydney and Melbourne (S3 and M3) before becoming more comfortable about the future direction of the business.
However, Morgan Stanley considers the business remains subject to long-term structural tailwinds, noting there is strategic value in the asset class and highlighting the recent AirTrunk transaction (Macquarie Infrastructure has bought a majority stake in AirTrunk). Singaporean group AirTrunk is building a 110 MW hyper-scale centre in North Sydney which is expected to open for business this year.
FNArena’s database has five Buy ratings and one Hold (Ord Minnett) for NextDC. The consensus target is $8.64, suggesting 11.5% upside to the last share price.
