CyrusOne: This 3%-Yielding Data Center REIT Should Continue To Deliver – CyrusOne Inc. (NASDAQ:CONE)

Investment Thesis

CyrusOne (CONE) delivered strong Q1 2019 earnings with solid top and bottom lines growth. The company should be able to continue to grow its business at a fast pace thanks to favorable industry tailwind. Its active development pipeline should also fuel growth in the next few years. The company has consistently increased its dividend in the past and is a good candidate for dividend growth investors.

Data by YCharts

Recent Developments: Q1 2019 Highlights

CyrusOne delivered a solid Q1 2019 with double digit top line and high-single digit bottom line growth. As can be seen from the top chart below, its revenues grew to $225 million in Q1 2019. This was a growth rate of 14% year over year. Its adjusted EBITDA grew to $119.2 million or 9% growth year over year. The company has a backlog of $39 million in annualized revenue in Q1 2019. In the past quarter, the company has acquired 22 acres of land in San Antonio and 8 acres of land in Santa Clara. Management plans to build two data centers on these two sites (120MW of power capacity in San Antonio, and nearly 200 MW of power capacity in Santa Clara).

Source: Q1 2019 Supplemental

Earnings and growth analysis

Favorable industry trend

CyrusOne should benefit from strong demand for data centers. According to Market Research Future, this market is expected grow by a compound annual growth rate of 28% through 2023. This should result in strong demand for data center spaces.

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Source: Market Research Future

Mostly focused in the United States

Unlike its peer Equinix (NASDAQ:EQIX), CyrusOne is mostly focused in the United States. As can be seen from the table below, U.S. represents about 95.4% of its total colocation space. The company has a much smaller portfolio in Europe (4.5% of its portfolio) and Singapore (0.07% of its portfolio). This means that CyrusOne is in a disadvantageous situation to attract customers that will require interconnections globally. We believe having interconnected locations are crucial to keep its churn rate low in the future. This may not be evident when demand for data centers continue to thrive. However, when the demand diminishes, we think CyrusOne’s churn rate may go up considerably. In fact, CyrusOne’s churn rate of 5% ~ 7% (expected in 2019) is higher than Equinix’s churn rate of 2% ~ 3%.

Source: Q1 2019 Supplemental

An active development pipeline

CyrusOne has an active development pipeline with 190 thousand square feet of space under development. These development projects will increase its capacity by 82MW. As can be seen from the table below, the focus is on Europe as this should significantly increase its European portfolio by adding 129 thousand square feet of space (currently the space is 182 thousand square feet in Europe).

Source: Q1 2019 Investor Presentation

Strong balance sheet

CyrusOne has a sound balance sheet with a net debt to adjusted EBITDA ratio of 5.2x. This is still higher than Equinix’s 3.6x. The company has no debt maturities until 2023 with $1.55 billion of available liquidity. Therefore, CyrusOne does not need to worry about debt refinancing in the next few years. Its sound balance sheet should allow it to pursue its development projects to grow its business.

Valuation Analysis

CyrusOne estimates it will generate about $3.30-$3.40 of adjusted funds from operations per share in 2019. Using the midpoint of its guidance, its price to 2019 AFFO ratio is about 18.1x. This is several multiples below Equinix’s 22.7x. We feel this is warranted given Equinix’s strength in its business and its better growth outlook.

A growing 3.0%-yielding dividend

CyrusOne currently pays a quarterly dividend of $0.46 per share. This is equivalent to an annualized cash dividend of $1.84 per share. As can be seen from the two charts below, the company has consistently increased its dividend every year. While CyrusOne has increased its dividend every year, its payout ratio remains low. Its payout ratio is only about 55% of its projected 2019 AFFO. As the chart below shows, CyrusOne’s current dividend yield of 3.0% is in the middle of its 6-year yield range of 2.5% and 3.7%.


Data by YCharts

Risks and Challenges

Risk of technological advancement

Cyrus faces the risk of technological advancement. Future development of technology (such as increase in disk and chip density or increase in usage of virtualization) may result in less demand for data center space. Other technology trends such as Infrastructure-as-a-Service (“IaaS”) may result in a migration from enterprise-owned servers to these IaaS providers.

Land acquisitions may be too aggressive

Cyrus has acquired about $200 million of land in 2018. The company has also purchased lands in San Antonio and Santa Clara in 2019. The lands acquired will be used to build more data centers. While we like the growth outlook of data centers, CyrusOne’s strategy to acquire lands may be too aggressive. There is a possibility that in an economic downturn, the demand for data center spaces may diminish quickly. This may result in vacancies in a lot of its data center spaces.

Investor Takeaway

We believe CyrusOne will continue to enjoy strong tailwinds due to favorable industry trend. The company should be able to continue to deliver high single digit or low double digit top and bottom lines growth rate. It has a growing dividend with a yield of about 3%. Its shares are not expensive at this price. We think the stock is a good investment choice for investors with a long-term investment horizon seeking both capital gain and dividend growth.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

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