CapitaLand Ascendas REIT: Capitalising on the growth of digitalisation and e-commerce

·       Previously, we highlighted CapitaLand Ascendas REIT’s resiliency in the face of higher rates, strong growth potential for its logistics assets in Singapore and having a strong sponsor to pave the way for future acquisitions and impose greater financial discipline on the REIT.

·       Apart from that, we see growth potential in other business segments – its data centres in Singapore and Europe as well as logistics assets in Australia.

·       Data centres are increasingly crucial as countries seek to adopt artificial intelligence and as businesses get increasingly digitalised. E-commerce in Australia has also shown greater growth driven by its infrastructure and population demographics. This in turn could result in a sustained demand for its data centre and logistics assets.

·       These assets have shown stronger occupancy rates than their respective industrial averages and we expect positive rental reversions as their leases expire in the near term.

·       Our 2025 target price for CLAR is SGD 3.14, derived from a dividend discount model with a terminal growth rate of 2% and a cost of equity of 7%. This implies a 8.7% upside alongside an average forward dividend yield of 5.3%.

In our previous article, we ran stress-tests on CapitaLand Ascendas REIT (SGX:A17U) (CLAR) against its large cap peers, and determined that it was the most resilient in terms of the availability of buffer and near-term refinancing risks. We also identified supply chain tailwinds which would fuel rental reversions for its logistics properties in Singapore. With the strength of its sponsor, we think the REIT is well-positioned for future acquisitions while maintaining financial discipline.

Related Article: CapitaLand Ascendas REIT: A shelter from the SREIT storm

In this article, we further analyse CLAR and highlight the growth potential in its other business segments that are deserving of investors’ consideration. These business segments include its data centres in Singapore and Europe and logistics assets in Australia.

Data centres are increasingly important in the current landscape as businesses get digitalised. Not only do they act as the invisible powerhouse for e-commerce, they are also integral to the rapid adoption of artificial intelligence (AI). Moreover, as businesses expand online, the rise of e-commerce would drive the need for logistics assets.

We find CLAR to be a suitable choice for investors seeking a diversified portfolio with a growing emphasis on data centres and logistics assets.

Diversified portfolio

As of 30 September 2023, CLAR’s diverse portfolio is comprised of (i) Business Space accounting for 39% of the portfolio by asset value, (ii) Logistics (25%), (iii) Industrial (19%), (iv) Life Sciences (8%), and (v) Data Centres (9%).

Given the challenged US commercial real estate market, demand and valuation among its US business space assets have declined. However, the management has shared that this segment has largely stabilised, with its overall portfolio occupancy rate standing at 94.5% in 3Q23, higher than its 10-year average of 90.6%. Moving forward, we see bright spots in its logistics assets and data centres, which could offset the downside risk posed by its US business space assets.

Geographically, CLAR’s data centres are located in developed markets such as Singapore, the UK and Europe, with UK making up the largest weight in terms of gross revenue (Figure 1). As for its logistics properties, Singapore makes up the highest gross revenue followed by Australia (Figure 1).

To further capitalise on the growth of the technology sector and logistics, the management has shared their intention to reallocate their portfolio towards these sectors by identifying potential acquisitions in the logistics properties and data centres in UK and Singapore.

Figure 1: Geographical breakdown of data centres and logistics properties by gross revenue

Data centres are increasingly crucial as countries look to incorporate AI

With the rapid adoption of AI by various countries, the importance of data centres has grown significantly. Data centres are centralised facilities that provide crucial infrastructure for the development and deployment of AI. They offer the computational power needed for intensive tasks like deep learning, storage capacity for vast datasets, and scalable resources to meet the growing demands of AI applications.

The increasing demand for data centres has also increased the emphasis on making data centres more environmentally friendly and sustainable in the long term. Specific energy efficiency standards are required before data centres can be approved for construction or expansion. Governments, companies in the data centre industry, and environmental organisations are collaborating to innovate and create solutions such as advanced cooling systems and the use of renewable sources of energy.

Singapore

Being in a tropical climate, running data centres proves to be a challenge as additional energy is required to cool these systems. In 2020, 7% of Singapore’s energy consumption came from data centres, triggering the need for a moratorium. Even though the moratorium has ceased in 2022, the new supply of data centres is kept low to balance the demand of the digital economy and the need for sustainability. As the government seeks to maintain stringent energy requirements, only 80 megawatts (MW) of new data centre capacity (existing installed data centre capacity is more than 1000 MW) have been approved. 

According to CBRE, Singapore holds the title of being the most power-constrained data centre market globally, with an available capacity of less than 4 MW and a low vacancy rate of less than 2% based on latest figures. Consequently, the city-state has the highest rental rates globally for its data centre facilities (Figure 2).

Figure 2: Rental rates for data centres in USD per kW across cities

Unsurprisingly, CLAR’s Singapore data centres are fully occupied based on latest figures as of 1H23 and enjoyed strong positive rental reversions of 9.7% and 8.6% in 2Q23 and 3Q23 respectively. As we expect the supply of new data centre capacity to remain low, CLAR’s data centres could continue to benefit from the high demand driven by the digital economy.

Frankfurt, London, Amsterdam and Paris (FLAP)

The FLAP region, comprising Frankfurt, London, Amsterdam and Paris, is home to some of the best data centres in Europe. It is also where most of CLAR’s overseas data centres are located.  In this region, data centre supply grew as providers strive to meet robust AI-driven demand. Large data centre development and megaproject deliveries were completed last year, with the majority of them being in London and Frankfurt. Despite macroeconomic challenges and new supply, demand for data centres remains high, causing the average vacancy rate across the region to fall to 14.5% as of 1H23.

In 3Q23, CLAR acquired a data centre in London, bringing four out of five of its UK data centres to be located in this city. According to CBRE, the UK leads as Europe's largest colocation data centre market in terms of total operational capacity, with London concentrating nearly 80% of the supply.

London stands out as the most interconnected gateway city in Europe, offering a multitude of fibre connectivity options, making it an ideal location for global peering traffic, low latencies, and network redundancies. With the growing demand for data centres and the declining available capacity of these assets, London possesses one of the highest rental rates in Europe. CLAR’s data centres in London enjoy an average occupancy rate of 85.8% based on latest figures as of 1H23, slightly above the industry average of 83.0%.

For Europe as a whole, we note that the data centres had no rental reversions last year as none of their leases expired. However, we expect positive rental reversions for its data centres in the near term as 29.4% of its leases in Europe (made up of DC) will expire in 2024 and 2025.

Quality assets in Australia's e-commerce and logistics landscape

In terms of property value, most of CLAR’s logistics assets are located in Australia. These assets are well-positioned to leverage the growth of Australia's e-commerce market which is ranked 12th globally. With an expected robust CAGR of 7.4% from 2023 to 2027, Australia's e-commerce market is projected to reach USD 63,080.5 million by 2027. Notably, the e-commerce penetration rate is four years ahead of its pre-pandemic trend, higher relative to other developed markets which have broadly moderated to their pre-pandemic trend.

Driven by several factors, Australia's e-commerce could see greater growth (Table 1). To start off, Australia’s infrastructure allows households to have fixed broadband subscriptions which results in an urban and tech-savvy population. This in turn leads to a higher mobile internet ratio as well as the wide adoption of digital mobile payment methods.

Table 1: Key e-commerce drivers in Australia

The surge in e-commerce, particularly in the food products category, underscores the importance of logistics assets' locations. Notably, the share of Australia’s online grocery spending on fresh food has risen from 16% to 38% yoy as of 3Q23, highlighting the need for timely delivery of perishables to meet consumer expectations.

Figure 3: Australia grocers’ online spending by product type

To accommodate the growing demand for internet sales, Australia's logistics space is expected to expand with 850,000 square metres forecasted between 2023 and 2027. However, the imbalance between logistics demand and supply has led to Australia's vacancy rate being the lowest globally at 0.8%, resulting in accelerated rental growth (Table 2). With 70% of CLAR’s Australian investments being in logistics properties, these assets could benefit from the low national vacancy rate.

Table 2: Australia’s super prime current average rent and yoy rent growth

Based on latest figures as of 1H23, CLAR's portfolio of logistics assets in Australia maintains a 100% occupancy rate. Notably, 88.5% of these properties are strategically located near expressways, optimising distribution networks for tenants and enhancing supply chain management. Additionally, the assets are equipped with modern warehousing facilities, some of which are temperature-controlled, aligning with the evolving needs of industries and enhancing CLAR's attractiveness to potential tenants. This strategic approach ensures that CLAR's tenants can meet the rising consumer delivery expectations. We note that 83.9% of its expiring leases in Australia would be coming from logistics properties this year, and expect positive rental reversions.

In conclusion, CLAR’s adept management of logistics properties in key Australian cities would allow it to capitalise on the tailwinds of e-commerce growth. We believe strong demand and limited supply would further drive rental reversions for CLAR’s logistics properties, particularly given their quality and locations. This is especially true as tenants look to secure prime locations for distribution – thereby, optimising its supply chain management. CLAR’s strategic advantage in the face of upcoming developments and its track record of full occupation rates position it as a robust player in Australia's evolving real estate landscape.

Risks:

Prolonged disruptions in shipping routes

Uncertainties involving shipping routes remain as drought in the Panama Canal persists, the South China Sea dispute, and the Red Sea crisis. These events can cause potential delays in shipments and affect CLAR’s tenants in the supply chain industry. Tenants may have to incur higher shipment costs and opt for air cargo, which could affect their ability to meet rental obligations.

Valuation:

We used a dividend discount model (DDM) to value CLAR, as the REIT has been paying out regular dividends. Our estimates have factored in contributions from new acquisitions, rental reversions and increased refinancing costs in the near term, alongside a dividend payout ratio of 97% (equivalent to its recent payout ratios).

Based on a cost of equity of 7% and a terminal growth rate of 2%, our 2025 target price for CLAR is SGD 3.14, illustrating an 8.7% upside potential relative to its share price as of 26 January 2024. We are also expecting an average forward dividend yield of 5.3%.

In short, investors looking to invest in S-REITs should consider CapitaLand Ascendas REIT (SGX: A17U) for its resilience in terms of buffer and near-term refinancing risks, coupled with the growth potential in its data centres and logistics assets that could offset the downside risk posed by its US business space assets.

Table 3: DPU Growth

Figure 4: Share Price and Distribution per Unit 

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.