digital real estate (DLR -1.88%) belongs to a select group. It’s one of just a handful of real estate investment trusts (REITs) to have increased its dividends in every year of its public existence. The data center operator last gave investors a 5% raise in March 2022, marking its 17th straight year of dividend growth.
However, this streak could run into trouble. The data center REIT recently released its 2022 results and outlook for the coming year, which showed its cash flow may not grow in 2023. Combined with its rising debt ratio, Digital Realty may not be able to continue growing its dividend.
Headwind meets the company’s results
Digital Realty has faced several headwinds over the past year. Despite these problems, the company continued to grow. Revenue rose 6% to nearly $4.7 billion, while core funds from operations (FFO) per share rose 2.6% to $6.70 from $6.53 in 2021 increased in the past year. Excluding the impact of exchange rate fluctuations, core FFO would have been $6.91 in 2022. Meanwhile, higher electricity prices and other costs caused its same-store cash net operating income (NOI) to fall 5.8% over the past year. The company was able to offset these headwinds and increased core FFO thanks to a boost from acquisitions and development projects.
The REIT expects to continue growing this year. Revenue is expected to increase to $5.7 billion to $5.8 billion, driven by improved lease renewal rates (up more than 3% in 2023 after growing 1.8% last year) and higher occupancy (85% to 86% in 2023 versus 84.7% in 2023). 2022). These factors should lead to NOI growth of 3-4% this year.
Despite all of these growth drivers, however, Digital Realty sees core FFO per share between $6.65 and $6.75 per share, or about flat year over year. This is partly due to the impact of higher interest rates.
Why dividend growth could run into trouble
With a current dividend payout of $1.22 per share per quarter ($4.88 per share annualized), Digital Realty’s dividend payout ratio would increase if it increased the payment this year given its core FFO likely to stagnate. The company has some cushion given its current dividend payout ratio of around 72%. However, increasing the dividend would mean the company doesn’t retain that cash flow to fund new investments.
That could weigh on the company’s balance sheet. On the plus side, it has a strong investment grade credit history. However, leverage is on the rise. The ratio of net debt to adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) has increased from 6.1x at the end of 2021 to 6.9x at the end of last year. If leverage continues to increase, Digital Realty risks a credit rating downgrade, which would further increase its borrowing costs.
That’s worrying given the level of investment the company has on the horizon as it continues to grow its global data center portfolio. Digital Realty plans to invest between $2.3 billion and $2.5 billion in development projects this year. While these expansion projects will help increase cash flow going forward, the company needs to fund these expenses. It plans to fund that investment by issuing $1 billion to $1.5 billion in debt and selling $1.5 billion to $2.5 billion in assets. This funding plan will allow the company to meet its financial obligations without selling shares at the current low price (shares are down nearly 30% from their peak early last year).
The series could end this year
Digital Realty is among a select group of REITs that have increased their dividends every year. While the company likely wants to remain in this elite category, it doesn’t want to risk damaging its financial profile. As such, the company may not increase its dividend this year, or opt for a very small increase.
That would ensure it retains the financial flexibility to meet its current challenges and continue to invest to fuel future growth. Despite this lack of near-term growth, Digital Realty still offers an attractive 4.5% dividend yield, allowing investors to get paid well while they wait for renewed acceleration.
Matthew DiLallo has positions at Digital Realty Trust. The Motley Fool has positions in and recommends Digital Realty Trust. The Motley Fool has a disclosure policy.
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