A friend recently reminded me of a scene from sci-fi classic The Minority Report. In it, the Tom Cruise character has his retina automatically scanned upon entering a futuristic shopping mall. Electronic billboards talk directly to him and provide targeted ads.
What seemed far-fetched 15 years ago, when the movie premiered, seems eerily prophetic today. Our irises might not be scanned on shopping expeditions, but smartphones, geotagging and other technology are giving retailers unprecedented customer insight.
Nobody knows for sure how this Brave New World of big data will play out. But it is a safe bet that companies will capture, analyse and store more data than ever. And that the value of data will rise, encouraging companies to outsource its storage to specialist providers.
This trend explains my bullish view on data-centre provider NextDC for The Bull over the past few years. NextDC has a valuable first-mover advantage in one the great global business megatrends: data capture and storage, and cloud computing.
I have also outlined a positive view on NextDC spin-off Asia Pacific Data Centre Group (APDC) – a real estate investment trust (REIT) that owns data centres and counts NextDC as its client.
Both companies are superbly leveraged to data trends. As our digital footprint rapidly expands, more data will be created and stored. Much of it will be “content rich” – video and audio data, for example. Companies will hold vast oceans of data in their servers.
At the same time, the threat of cybersecurity and data loss will underpin demand for offsite servers. Storing data in state-of-the-art, specialist centres will make more sense than holding it on internal servers at corporate headquarters.
NextDC soared from $2.50 in February 2016 to $4.46 in October 2016 as the market latched on to its rapidly improving profitability. But it tumbled to $2.80 in December that year, amid the broader sell-off in high Price Earnings (PE) small- and mid-cap stocks.
Chart 1: NextDC
Source: The Bull
NextDC now trades at $3.68 after spiking 4 per cent on its interim result last week. The market, it seems, became too bearish on the company during its share-price selloff.
The company’s interim result for FY17 impressed. Revenue rose 39 per cent to $58.7 million. Underlying earnings jumped 110 per cent to $23.9 million. Customer volumes grew 23 per cent and facility utilisation leapt 32 per cent.
Revenue was broadly in line with market estimates and the jump in underlying earnings beat consensus. Simply put, NextDC engineered a 110 per cent lift in underlying earnings on 39 per cent revenue growth. That shows the operating leverage in its business model.
This is the beauty of NextDC and its mostly fixed cost base. Attracting more customers spreads sunk costs. Growth in underlying earnings outpaces growth in revenue because the cost to serve each customer falls as volumes increase. It’s a great model when it works.
As the data-centre ecosystem grows, more customers store more information. That, in turn, drives higher profit margins and customer-retention rates. More of this revenue growth goes straight to the bottom line, boosting NextDC’s intrinsic value and ultimately its share price.
NextDC’s guidance shows the potential. The company expects revenue growth of 24-31 per cent on FY16 and underlying earnings growth up 66-81 per cent. How many other Australian companies expect underlying profit growth of up to 81 per cent in FY17?
Development costs at its Sydney, Melbourne and Brisbane facilities will probably constrain NextDC’s margin expansion in FY17 and FY18 as the new centres ramp up.
Three of nine broking firms that cover NextDC have a buy recommendation. Six have a hold. A median share-price target of $4.72 suggests the company is significantly undervalued at the current price. The lowest price target among brokers is $4.01.
I am not quite as bullish as the consensus. A lot of growth is already factored into NextDC and large new contracts are needed to re-rate the price further in the lead-up to the September full-year result. But a 12-month total return above 20 per cent (including dividends) is plausible for one of the market’s best-run small-cap companies.
Like NextDC, Asia Pacific Data Centre Group (APDC) drifted lower in the fourth quarter of 2016 after stronger earlier gains. It eased from a 52-week high of $1.67 to $1.43 for no apparent reason other than the broader small- and mid-cap stock sell-off. The REIT now trades at $1.52, having almost touched $1.60 earlier this year.
Chart 2: Asia Pacific Data Centre Group
Source: The Bull
APDC delivered another solid interim result in February. At the current price, it trades at a premium to its latest stated net tangible assets of $1.43.
APDC typically traded at a discount to NTA after listing, principally because of its one-tenant risk through NextDC. APDC’s state-of the-art data centres in Sydney, Melbourne and Perth are leased to NextDC.
But as NextDC’s operating performance improves, its tenancy risk for APDC falls. As I have written before for The Bull, APDC is a lower-risk way to play the cloud-computing boom compared to NextDC (but higher risk than larger, diversified REITs).
APDC has a trailing 7.2 per cent yield and capacity for small, steady distribution increases in the next few years.
APDC should benefit from stable, inflation-linked revenue growth and NextDC funding ongoing capital and maintenance requirements through triple-net leases. That, in turn, reduces APDC’s development risks and is an important difference over small REITs with higher capital expenditure risks.
There’s much to like about these stocks, both of which suit experienced investors who are comfortable with small-caps. NextDC has the higher risk, while APDC suits income investors who seek yield and are willing to use micro-caps to achieve it.
Tony Featherstone is a former managing editor of BRW and Shares magazines. The information in this article should not be considered personal advice. The article has been prepared without considering your objectives, financial situation or needs. Before acting on the information in this article you should consider its appropriateness, regarding your objectives, financial situation and needs. Do further research of your own or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at March 2, 2017.