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The history of capital markets gives us plenty of examples where a megatrend has lifted the stocks of companies that are not only at the front and center of the action, but also the ancillary industries. To use the “Gold Rush” example, semiconductors like the ones designed by Nvidia (NVDA) might be the proverbial “picks and shovels” of the artificial intelligence (AI) juggernaut - but as it turns out, all of those massive, high-powered chips aren't just hanging around, gathering dust in basement storage at Big Tech companies.
Instead, they're housed in massive, specialized data centers, one of the AI-adjacent niche industries that's turning into a virtual boom town for investors. While AI is forecasted to add a staggering $15.7 trillion to the global economy by 2030, data centers should be a key beneficiary of that growth. According to real estate consultancy firm JLL, as the demand for AI multiplies in the coming years, data center storage capacity is expected to grow from 10.1 zettabytes (ZB) in 2023 to 21.0 ZB in 2027, for a five-year compound annual growth rate of 18.5%. Adding to the optimism around data centers, this report forecasts an additional 120-130 hyperscale data centers will come online each year over the next decade.
Given that market opportunity, here are two data center picks from the real estate investment trust (REIT) industry, which not only provide AI-fueled growth potential, but a passive income stream in the form of regular dividend payments. Let's have a closer look.
#1. Equinix
Founded in 1988 and based out of Redwood City, Equinix (EQIX) provides colocation space, interconnection services, and cloud computing solutions, essentially acting as a neutral meeting ground for different networks and cloud providers. Equinix operates the world's largest interconnected data center platform with over 210 data centers in 55+ major metros across 25+ countries, offering a vast network for customers. The company's market cap currently stands at $76.4 billion.
EQIX stock has underperformed in 2024 so far, with the shares roughly flat on a YTD basis. At its current price, the REIT offers a dividend yield of 2.01%, and the company has been raising its dividend continuously for almost a decade.
The results for the first quarter saw Equinix reporting a 6.5% yearly increase in revenues to $2.13 billion. Funds from operations (FFO) per share, a key component to assess the operational strength of REITs, slipped by 1% over the same period to $5.81, missing the consensus estimate of $5.90 per share - though adjusted FFO (AFFO) of $8.86 per share comfortably beat expectations.
The company generated net cash from operating activities of $598 million in the quarter (down 13.6% YoY) and closed the quarter with a cash balance of $1.53 billion (down 27.1% YoY). However, long-term debt levels also fell to $15.97 billion from the previous year's $16.2 billion. Currently, Equinix is the only S&P 500 company that has a track record of clocking 85 consecutive quarters of positive revenue growth.
Equinix has become the world's largest data center REIT, with a market share of more than 40% in the world's largest cloud platforms, including Amazon's (AMZN) AWS, Microsoft's (MSFT) Azure, Alphabet's (GOOGL) Google Cloud, and Oracle (ORCL). In fact, the majority of its revenues come from companies with at least $1 billion in annual revenues and more than 30 data centers. A key reason for its reliability among a stellar customer base lies at the 99.9%+ reliability assurance of the company's data centers, along with a pledge to move to 100% renewable power.
Analysts have a consensus rating of “Strong Buy” for EQIX stock, with a mean target price of $902.09. This indicates an upside potential of about 11% from current levels. Out of 26 analysts covering the stock, 19 have a “Strong Buy” rating, 1 has a “Moderate Buy” rating, and 6 have a “Hold” rating.
#2. Digital Realty Trust
Founded in 1994 and based out of San Francisco, Digital Realty Trust (DLR) is one of the foremost names among data center REITs in the world. They own, acquire, develop, and operate data centers around the world, leasing out space and related services to businesses that require robust IT infrastructure. This has led to the company commanding a hefty market cap of $49.8 billion.
DLR stock is up 20.6% on a YTD basis, and it offers a dividend yield of 3.06%. The company has been paying out dividends consistently over the past 15 years.
In the latest quarter, Digital Realty's numbers were a mixed bag, as FFO surpassed estimates but revenues missed the mark. Revenues for the first quarter came in at $1.3 billion, down by 1% from the prior year, even though core rental revenues inched up by 2.7% in the same period to $894.41 million. However, core FFO per share increased marginally to $1.67 from $1.66 in the previous year. The figure also outpaced the consensus estimate of $1.62.
DLR's cash net operating income improved by 3.8% from the previous year to $722.5 million, and the company closed the quarter by significantly fortifying its cash position. The company's cash and cash equivalents balance at the end of the quarter was $1.2 billion, compared to a mere $131.4 million in the prior year.
On the conference call, DLR maintained its core FFO guidance range for 2024, targeting $6.60 and $6.75 per share, and also backed its total revenue and adjusted EBITDA guidance ranges for 2024. However, cash releasing spreads are now expected to increase 5% to 7% in 2024, up from the prior 4% to 6% guidance, while same-capital cash NOI is now expected in the 2.5% to 3.5% range, compared to the February forecast of 2% to 3%.
Notably, Digital Realty has a geographically diversified revenue stream, with the most lucrative markets of U.S. and Europe accounting for 52% and 23% of total sales in Q1, respectively. Additionally, the company is also benefiting from its investments and joint ventures, with the REIT still reporting available pockets of remaining capacity in two of its campuses in Northern Virginia.
Overall, analysts have deemed DLR stock a “Moderate Buy.” Out of 23 analysts covering the shares, 14 have a “Strong Buy” rating, 1 has a “Moderate Buy” rating, 7 have a “Hold” rating, and 1 has a “Strong Sell” rating.
While the REIT is already trading at a premium to its mean target price of $154.09, the Street-high target price of $185 indicates an upside potential of about 14% from current levels.
