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Market Overview - June 2024

Market Overview

Global markets maintained upward momentum in June (MSCI World Index: +2.3%, MSCI Emerging Markets Index: +3.5%), with emerging markets stepping into the spotlight and outperforming as political uncertainty within certain key regions began to fade. In addition to ongoing monetary policy commentary, the AI theme also continued to dominate the headlines with a large portion of upside momentum being driven by the large tech companies as the NYSE FANG+ Index rallied more than 10% at the time of writing.

US markets staged a strong front for the month with the S&P 500 Index adding 4% as the tech space continued to fuel upside momentum while the broader market, as represented by the Russel 2000 Index (-1.4%), remained under pressure. Nvidia (+13.1%) and Meta (+11.4%) were among the standout performers. In terms of central bank activity, the Federal Reserve left its target range steady at 5.25% to 5.50% for a seventh consecutive meeting in June 2024, in line with forecasts. The decision was accompanied by the Federal Open Market Committee's (FOMC) quarterly economic projections, which includes the fabled dot plot that shows its interest rate outlook. This dot plot shifted to less dovish, as expected, and it now suggests 25bps in cuts in 2024 (down from 75bps in March). Fed Chairperson, Jerome Powell, struck a similar tone to what he has in recent press conferences, stressing that the committee was prepared to act if there was a sharp deterioration in the labour market. He also indicated that "some" participants revised their forecasts post the CPI readings but that "most" did not. The CPI print came in lower than expected and prompted a strong positive market response. The options and futures markets are now both pricing in two cuts this year (one in September and one in December), suggesting that the market may have run slightly ahead of itself.

The Eurozone delivered a lacklustre performance with the Euro Stoxx 600 Index falling by 0.9% as political uncertainty in France herded investors away from riskier assets. In addition, the European Central Bank (ECB) has moved ahead of the US, joining the likes of Canada, Sweden, and Switzerland in lowering rates. The ECB cut interest rates by 25bps, in line with expectations, marking a shift from nine months of stable rates after inflation declined by more than 2.5ppts since September 2023. However, domestic price pressures remain elevated, and the council said it aims to keep policy rates sufficiently restrictive and has not pre-committed to a particular rate path, noting that "interest rate decisions will be based on its assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission".

China was also under pressure in June, with the MSCI China Index down almost 2% as investors have been discouraged by intensifying geopolitical tensions with the Western bloc, sparking debate over "a rise in anti-China sentiment in America". The US hiked tariffs on $18 billion worth of imports from China in May, targeting strategic sectors such as electric vehicles, batteries, steel and critical minerals, a move Beijing warned would "severely affect" relations between the two superpowers. Market participants have also been monitoring recent economic data and ongoing stimulus talks, with the focus shifting towards the highly anticipated Third Plenum meeting that will take place in July 2024. The Third Plenum carries historical significance and has previously spurred transformative periods of China's economic policy.

Locally (JSE All Share: +3.1%; USD: +5.1%), equites, bonds and the rand saw a sizable rebound as heighted uncertainty surrounding the 2024 general election subsided with ANC President Cyril Ramaphosa announcing that the party had decided to invite other political parties to form a Government of National Unity (GNU). This followed days of speculation around a possible way forward after the party fell to below 50% support in the 29 May national elections. Ramaphosa noted that the GNU will be committed to tackling the pressing issues that South Africans want to be addressed including job creation, inclusive economic growth, the high cost of living, service delivery, crime, and corruption. While the long-awaited positive shift in sentiment initially drove the local bourse higher, skittishness returned to the market as the choosing of cabinet saw internal political dynamics return to the limelight. We caution that the external environment and political developments remain fluid, demanding a certain level of caution and a careful approach.

Economic data overview

US policymakers continue to wait for further certainty before cutting rates

Flash estimates showed that the S&P Global Composite PMI for the US rose to 54.6 in June, its highest level since April 2022, up from 54.5 in May, as per preliminary data. The service sector showed the most significant improvement, while manufacturing also contributed to economic expansion, although its growth slowed slightly. Retail sales edged up 0.1% in May (consensus: +0.2%), following a downwardly revised 0.2% fall in April, another sign that consumer sentiment is cooling. The trade deficit expanded to $74.6 billion in April, the largest since October 2022, moving from a downwardly revised $68.6 billion in March and below forecasts of a $76.1 billion gap. The unemployment rate rose to 4% in May from 3.9% in April, the highest since January 2022 and higher than market expectations for the rate to remain unchanged. The annual inflation rate decreased to 3.3% in May from 3.4% in April, the lowest in three months, coming in below the forecasted 3.4%. The Federal Reserve kept the fed funds target range steady, as expected, for a seventh consecutive meeting. Policymakers do not believe it will be appropriate to reduce rates until they have gained greater confidence that inflation is moving sustainably toward the 2% target. Meanwhile, the dot plot showed that policymakers see only one rate cut this year and four reductions in 2025. In March, the FOMC was seeing three cuts in 2024 and three in 2025. The committee made no revisions to its GDP growth projections.

ECB cuts rates ahead of the US

On a preliminary basis, HCOB Eurozone Composite PMI fell to 50.8 in June from 52.2 in May, considerably below market expectations of 52.5, but still signalled a fourth consecutive expansion in private economic activity. The expansion was solely carried by the services sector. Retail sales remained stagnant in April, following a 0.7% increase in March, and compared to forecasts of a 0.1% rise. The Eurozone posted a trade surplus of €15 billion in April, wider than €11.1 billion in the same month of the previous year and below market forecasts of €20 billion. Annual inflation in the Euro area was 2.6% in May (as expected), an increase from 2.4% in each of the two previous months. The ECB lowered rates by 25bps in June, in line with expectations, marking a shift from nine months of stable rates after inflation declined by more than 2.5pps since September 2023. However, domestic price pressures remain elevated, highlighting continued inflationary challenges. To address this, the Council aims to keep policy rates sufficiently restrictive, maintaining a data-dependent approach. The latest Eurosystem staff projections for both headline and core inflation were revised up for 2024 and 2025.

Bank of England (BoE) keeps rates steady in 'finely balanced' decision

Initial reports showed that the S&P Global UK Composite PMI fell to 51.7 in June, down from 53 in May, below market expectations of 53.1 and marking the weakest growth since November 2023. The slowdown was primarily driven by a deceleration in the service sector, despite a stronger performance in manufacturing. Retail sales increased 1.3% y/y in May, rebounding from an upwardly revised 2.3% drop in April and beating forecasts of a 0.9% decline. The UK's trade deficit widened to a near two-year high of £6.75 billion in April, up from £1.10 billion in March, as imports rose 7.2% and exports fell 0.7%. The unemployment rate rose to 4.4% from February to April, compared to market forecasts and the previous three-month period's 4.3%. The BoE decided to maintain the repo rate at 5.25% during its June meeting, as expected. Some policymakers noted that the decision not to cut rates was "finely balanced". Recent economic indicators show inflation has returned to the target of 2%, driven by moderating inflation expectations and declining energy prices. GDP growth has exceeded expectations, but underlying economic surveys suggest that the pace of expansion slowed. The MPC acknowledged a looser labour market despite tight historical standards and is committed to maintaining a restrictive monetary policy until inflation risks diminish sustainably. They remain vigilant about persistent inflationary pressures and will adjust policy as necessary based on upcoming economic data and forecasts.

China's concerns reignite over 'effectiveness' of stimulus measures and deepening geopolitical tensions

The Caixin China General Composite PMI rose to 54.1 in May, an increase from 52.8 in April, reflecting the highest reading since May 2023. It was the seventh straight month of growth in private sector activity, with output growth accelerating in manufacturing and services. Retail sales rose by 3.7% y/y in May, exceeding market forecasts of 3% and accelerating from a fifteen-month low of 2.3% in April. China's trade surplus widened to $82.62 billion in May from $65.55 billion in the same period a year earlier, exceeding market forecasts of $73 billion, due to exports growing much more than imports. The surveyed unemployment remained at 5% in May, unchanged from April's five-month low and matching market forecasts. China's annual inflation rate held steady at 0.3% in May for the second month in a row, missing market forecasts of 0.4%. It was the fourth straight month of consumer inflation, pointing to an ongoing recovery in domestic demand. The People's Bank of China (PBoC) kept key lending rates unchanged at the June fixing, matching market expectations. The one-year loan prime rate (LPR), the benchmark for most corporate and household loans, was maintained at 3.45%. While the five-year rate, a reference for property mortgages, was retained at 3.95% following a record cut of 25bps in February. Both rates are at record lows amid a fragile economic recovery that has reinforced calls for more support measures from Beijing. Central Bank Governor, Pan Gongsheng, mentioned that they will flexibly use various policy tools and that Beijing will prevent the yuan from overshooting.

Bank of Japan (BOJ) to 'significantly' scale back bond buying in shift on ultra-loose policy

Early estimates showed that the Jibun Bank Composite PMI fell to 50 in June 2024 from a final reading of 52.6 in May. It was the lowest figure since December 2023, as services activity contracted for the first time since August 2022, while the manufacturing sector expanded at a softer pace. Retail sales increased 1.2% in April, rebounding from a 1.2% drop in March. On an annual basis, retail sales grew 2.4% in April, accelerating from a downwardly revised 1.1% rise in March and surpassing market forecasts of 1.9% growth. Japan's trade deficit decreased to ¥1.22 trillion in May 2024 from ¥1.38 trillion in the same month in 2023 and compared with market estimates of a ¥1.3 trillion shortfall. The unemployment rate stood at 2.6% in April, holding steady for the third straight month and aligning with market forecasts. The annual inflation rate accelerated to 2.8% in May from 2.5% in April - the highest reading since February. The BOJ unanimously maintained its key short-term interest rate at 0% to 0.1% at its June meeting, as was widely expected, after delivering the first rate hike since 2007 and ending eight years of negative rates in March. At the same time, the board indicated that it may consider how to start reducing bond purchases at its July meeting. Additionally, the board mentioned that Japan's economy had recovered moderately despite fragility in some areas.

Local sentiment recovered somewhat as angst over elections dissipated

In April 2024, the composite leading business cycle indicator improved 2.4% m/m (following a decline of 1.1% in the prior month), marking a strong rebound in business activity. The SACCI Business Confidence Index dropped to a reading of 107.8 during May, and this was the second-consecutive monthly decline, with sentiment impacted by preceding fears over the national elections. Retail sales edged 0.6% higher y/y in April, slowing notably from an increase of 2.3% in March, but encouragingly above forecasts of a 1.8% decline. The trade balance in April amounted to a surplus of ~R10.5 billion (below expectations of ~R15 billion) as exports advanced 4.4%, while imports grew at a slower 3.8%.

Local mining production rose 0.7% y/y in April (compared to forecasts of a 0.9% increase), recovering from a drop of 4.8% in the previous month. This was driven by stronger output in chromium ore (+20.8%), other non-metallic minerals (+15.6%) and PGMs (+16.9%). Manufacturing production grew 5.3% y/y (vs. forecasts of a 2% decline), marking the strongest increase in industrial activity in almost a year. The S&P composite PMI edged higher to a reading of 50.4 in May (from 50.3 in April), signalling a further improvement in private sector activity, however, the ABSA Manufacturing PMI dropped sharply to a reading of 43.8 in May (April: reading of 54), implying a renewed contraction across the local manufacturing sector, due to slowing consumer demand.

As expected, annual consumer price inflation (CPI) was unchanged at 5.2% in May, underpinned by steady pricing of food and non-alcoholic beverages, housing utilities, education, and household content and services. Nevertheless, this remains above the SARB's target of ~4.5%. Core inflation (which excludes the price of food, non-alcoholic beverages, fuel, and energy) was also unchanged at a three-month low of 4.6%. The SARB left its benchmark interest rate unchanged at 8.25% during its meeting in May, with policymakers emphasising the need to bring inflation firmly within the targeted range. CPI is now expected to reach the targeted level of ~4.5% by 2Q25, much sooner than initial forecasts which stated 4Q25. The inflation projection for this year was left unchanged at 5.1%.

Market Outlook in a nutshell

Local

• Global activity highlights diverging developments as US resilience fades, China's recovery proves lethargic, while falling interest rates should support a modest recovery in much of the rest of the world. This is as central banks have begun to cut interest rates earlier than the US - where the risk of sticky inflation has kept the Fed cautious. That said, global trade risk remains elevated and could result in adverse growth and inflation outcomes.
• South Africa's outlook is viewed as more balanced, as ongoing structural reforms should incrementally reverse idiosyncratic inefficiencies. Nevertheless, the robustness of reform implementation hinges on the formulation of the seventh administration. The president's cabinet appointments could provide a boost in confidence in the state, allowing for higher business confidence. Should this confidence usher in robust structural investment and spending on big-ticket items such as property, it would support higher-than-expected economic growth.
• At this stage, we foresee real economic gains being gradual, with growth improving from 0.7% in 2023 to 1.6% by 2026. Therefore, current projections suggests that growth will not be at the required level to reverse fiscal slippage as unemployment remains elevated.
• However, a sustained improvement in sentiment should reduce risk aversion - supporting lower borrowing costs and less rand depreciation. This would mean that inflation and economy-wide debt-servicing costs become less binding on activity, providing much-needed relief to an indebted state, households, and small businesses.
• We currently project inflation to average 5% this year, falling to 4.5% over the period to 2026. In line with this, we anticipate a 25bps cut to interest rates before year-end and for rates to fall to 7.5% over the medium term.
• Given prevailing political uncertainty, there is more fluidity in our projections than usual.

Global

• US growth has held up very well over the last few quarters despite a very aggressive interest rate hiking cycle. However, GDP for 1Q24 came out at a 'disappointing' 1.3%, versus consensus estimates of 2.5%.In the last Bank of America survey participants continued to favour a better outcome for the US economy, with 64% calling for a soft landing, 5% for a hard landing, and a slowing 26% calling for a no landing (economy to grow above potential).The long and variable lags of monetary policy are in progress, but thus far the impact has been relatively small (as most companies/individuals have locked-in low rates). We expect this soft vs hard landing rhetoric to continue throughout the year as new data becomes available. Our house view is for US growth to underperform consensus in 2024 and 2025.
• Inflation has peaked but is proving to be sticky.
• The Fed's interest rate hiking cycle is over. The question for 2024 becomes the pace and quantum of the cuts. Markets are now pricing in only two interest rate cuts by the Fed for 2024, versus the six cuts priced into the market just a few months ago. The 'soft' landing narrative is based on the Fed cutting rates fast enough so real rates don't become too restrictive on the economy. Our house view has two cuts for 2024, starting in 3Q24.
• In emerging markets, it is encouraging to see the PBoC maintaining loose monetary policy and further injecting liquidity into the banking system. However, the recovery will remain fragile in the absence of fiscal stimulus targeted at restoring confidence to the consumer and addressing property sector issues. With low levels of inflation and notable excess savings combined with attractive valuation multiplies, we are of the belief that selected opportunities remain in the Chinese economy and will be on the lookout for more palatable policy responses from fiscal authorities. Economic data has been encouraging lately, with GDP for Q1 surprising to the upside (+5.3%) and PMI data also showing some improvements.
• With 'rates higher for longer', the US dollar has remained resilient. We expect the US dollar to remain well supported over the short term as interest rate differentials favour the greenback.
• Geopolitics are always important for asset markets, but the election calendar for 2024 is exceptionally busy. This year 76 countries will be voting, representing more than half of the world's population and over 65% of global GDP. This, together with two major ongoing wars, could exacerbate uncertainty and volatility over the next few months. The impact from these developments, especially on oil, should be monitored very closely.
• Given all the above uncertainties, we are closely aligned to our strategic asset allocation benchmarks, with a slight defensive twist. We slightly favour fixed income over equities.

Data centre real estate investment trusts (REITs)

By Pritu Makan

Data centre REITs own and manage highly specialised facilities that house critical IT infrastructure that powers today's digital economy. A wide variety of companies, including Amazon, Apple, AT&T, Google, IBM, Meta, Microsoft, Oracle, and Ubisoft, utilise these REIT-owned data centres to house servers and networking equipment to store and access data. These properties also include a variety of features to keep the servers and data safe, including uninterruptable power supplies, air-cooled chillers, and physical security. Just as e-commerce has driven warehouse and distribution facility demand and design, continuing developments in artificial intelligence (AI) are expected to fuel and shape the future of data centres.

As a result of the growing popularity surrounding these assets, FTSE, Nareit, and EPRA added data centres as a property sector to the global index series in 2019. Although a new addition, data centre REITs accounted for ~8.8% of equity market capitalisation of the FTSE Nareit All Equity Index as of 30 June 2023, nearly double the share of the office sector. In addition, CBRE Research shows that data centre inventory in US primary markets has nearly tripled from 2015 to 2022.

A data centre is a specially designed facility consisting of the building shell, electrical systems, heating, ventilation, and air conditioning (HVAC) and mechanical systems, and other commercial space. The data centre's purpose is to provide customers with reliable uninterrupted access to their data at any time.

As with a typical REIT, data centre REITs rent space in their facilities to tenants. These usually include multiple customers (as in co-location) or a single tenant (enterprise or hyperscale) utilising the entire facility. The tenants use this space to house their networking equipment and servers, allowing them to process and store data. In addition to renting space, data centre REITs provide several other specialised services to their customers, including reliable power, a regulated temperature, and physical building security. Data centre REITs also provide interconnection services to their clients, meaning a physical network connection between two parties.

In terms of client needs, data centres provide critical infrastructure to a variety of enterprise customers with different networking and computing needs. These include cloud computing which is the "outsourcing" of computing tasks and data storage from a local device to a more powerful and reliable off-site facility. AI has long been viewed as the natural evolution and next generation of cloud computing, which further leverages the potentially "unlimited" computing power of the offsite facility by integrating specialised hardware such as Graphics Processing Units (GPU) and Tensor Processing Units (TPU), in addition to the conventional Central Processing Unit (CPU) tasks.

The sector typically uses megawatts (MW) rather than square feet as its principal size measurement given that critical power supply, which is the "usable" or "sellable" power delivered to the computing space, is used to determine the value of a data centre and not the size of the building; one MW can power 1 000 homes. CBRE Research shows that data centre inventory in US primary markets has nearly tripled in recent years. Total inventory increased from 1 330 MW in 2015 to 3 929 MW in 2022 and currently stands around 7 000 MW. The size of the US data centre market is formidable, which is expected given the presence of major hyperscale tenants like Microsoft, Amazon, Google, and Meta, all of which are headquartered in the US and are primary drivers of data centre demand worldwide.

Data-powered growth

Data centre REITs have benefitted from the explosive growth in data usage over the years. This catalyst has allowed these REITs to expand their portfolios, driving fast-paced revenue, earnings, and dividend growth, with solid development pipelines being supportive of prospects. These trends are expected to remain dominant within the sector, given the current projections for data growth in the coming years. As a result, this provides an interesting space for investors to get involved in.

Among the top-performing property sectors this year, the Data Centre REIT rebound has been augmented by reports of "booming" demand for AI-focused data centre chips.

Data Centre REITs have been thrust back into the spotlight in recent months as the physical "epicentre" of the AI ecosystem after chipmaker Nvidia reported blowout first-quarter results in late-May. Nvidia saw continued strength in its data centre business and noted that it is "significantly increasing its supply of data centre chips" to meet "surging" demand resulting from investments in AI, which leverages the computing power of data centres to search massive datasets and to process intensive computing tasks to produce useful informative output. In its earnings call, Nvidia commented that it believes that "a trillion dollars" of installed global data centre infrastructure will transition from general-purpose computing to "accelerated" computing as companies "race to apply generative AI into every product and service." As a result, global leasing activity has Source: Company reports, RBC, Dgtl Infra surged, achieving record-breaking levels in each of the last four quarters - more megawatts have been leased over the prior twelve-month period than in the preceding three-and-a-half years.

Looking at the broader tech industry, companies that are synonymous with cloud computing - Amazon (AMZN), Microsoft (MSFT), Google (GOOG) (GOOGL), Alibaba (BABA), Oracle (ORCL), Salesforce (CRM), and Snowflake (SNOW) - are among the largest and most critical tenants of these data centre operators, and have become even more valuable tenants as a growing share of leasing activity has accrued to these "hyperscale" tenants who have increasingly dictated the terms of leasing agreements and pricing. While a larger share of leasing activity is indeed accruing to a smaller number of tenants, the overall pie continues to grow. The pendulum of pricing power swings between landlord and tenant over time based on market-level and national supply/demand dynamics, however, there is enough sustainable economic value to be shared by tenants and property operators.

Advantages of investing in data centre REITs

Data centre REITs allow investors to benefit from the growth in data usage. According to IDC, data usage is on track to grow at a 24% compounded annual rate through 2025. This is expected to drive the need for additional infrastructure to transmit and store data, including more data centre capacity. Another benefit of data centre REITs is that they tend to be recession-proof. This is because most tenants sign long-term contracts, allowing data centre REITs to generate healthy recurring revenue streams over a lengthy lease period.

More generalised advantages include:

• High-demand sector: The digital revolution has created a vast amount of data that needs to be stored, managed, and processed. This trend has been driven by several factors including cloud computing, AI, big data analytics, Internet of Things (IoT), and the rising trend of remote working. These factors are contributing to the surge in demand for data centres, making data centre REITs an attractive investment.
• Attractive dividend yields: As with all REITs, data centre REITs are required to pay out most distributable earnings (usually at least 90% of taxable income) - this provides higher dividend yields compared to other sectors, making them particularly suited for income-focused investors.
• Diversification: Investing in Data Centre REITs provides exposure to the thriving tech industry without the volatility associated with traditional mega cap tech stocks. These counters allow investors to diversity their portfolio by combining the steady income and capital appreciation potential of real estate with the growth of the tech sector.
• An inflation buffer: Real estate assets, including data centres, tend to hold up well against inflation. As prices rise, the cost to build new data centres increases as well, which bodes well for the value of existing data centres. Furthermore, many data centre leases contain rent escalations tied to inflation, providing an additional layer of inflation protection.

Risks of investing in data centre REITs

Data centre REITs are less risky than many other real estate investments and technology stocks. However, there are still several key risks that these REITs face, including:

• Interest rate risk: The current high interest rate environment continues to adversely affect the REIT sector (higher finance costs weigh on earnings) given the large level of borrowings that are required to fund extensive pipelines.
• Technology risk: Advancements in technology could make certain types of data centres obsolete, leading to a potential decline in revenues and higher occupancies.
• Oversupply risk: Data centre operators often build new capacity on speculation. If they build too many data centres, the surplus can affect occupancy levels and rental rates.
• Environmental risks (energy intensive): Data centres use a significant amount of energy and water to keep servers and networking equipment running and cool. As a result, they face environmental risks from climate change, erratic weather, and natural disasters, which can affect a data centre's ability to deliver 100% uptime.

Key companies in the sector

Several data centre REITs have emerged as key players in the sector. These include Equinix, Digital Realty Trust, CyrusOne, CoreSite Realty and QTS Realty, which have delivered consistent growth and strong returns over the past several years.

Equinix - a 'blue chip' REIT in the data centre sector

Equinix, one of the world's largest digital infrastructure companies, has more than 10 000 customers and 468 000 total interconnections on its systems, with an excellent track record and robust growth figures. As at 1Q24, the data centre REIT had increased its revenue in over 85 straight quarters, which the company claims is the longest track record of any company in the S&P 500. The company has continued to benefit from its high recurring-revenue business model, with ongoing expansion through ground-up developments and acquisitions providing further upside momentum.

With strong underlying demand for digital infrastructure, Equinix continues to invest broadly across its global footprint. The company currently has 50 major projects underway in 34 markets across 21 countries. This includes 14 xScale (hyperscale data centres joined with partner data centres - a hyperscale data centre has enough floor space to hold thousands of computing and storage systems and offers massive networking capacity and increased connectivity speeds) builds, representing more than 16 000 cabinets of retail capacity and more than 50 megawatts of xScale capacity through the end of 2024. More than 90% of current retail expansion capital expenditures are related to owned land or owned buildings with long-term ground leases.

The group's global interconnection franchise also continues to perform well. In 1Q24, Equinix interconnection adds increased to 6 200, supported by healthy gross adds activity and a moderation of consolidations into higher bandwidth connections.

Overall, the rapidly evolving AI landscape continues to serve as a catalyst for economic expansion, creating immense potential for Equinix as customers recognise the importance of digital initiatives in driving long-term revenue growth and operational efficiency. In addition to incremental pricing tailwinds, robust customer demand (in an increasingly supply and power-constrained market) across multiple sectors positions the group's platform as the trusted partner for digital leaders to interconnect and enhance the foundational digital infrastructure that powers the world.

Digital Realty

Digital Realty is one of the biggest data centre operators in the world. In addition to renting space in its facilities to companies to store their networking and storage equipment, Digital Realty also leases entire data centre shells to other operators, including fellow data centre REIT, Equinix.

Digital Realty has delivered excellent results over the years and has invested heavily in buying data centres to complement its organic growth. Those two growth drivers helped the data centre REIT expand its core funds from operations (FFO) at an 11% compounded annual growth rate since 2005. The REIT also has a strong financial profile, including an investment-grade credit rating and a sizable dividend payout ratio, providing the flexibility to continue growing in the future.

The group saw accelerating demand in the first quarter, executing on several multifaceted AI-oriented opportunities, while continuing to support hybrid multi-cloud requirements. Strong demand supported a new leasing record, driven by large footprint deals. As a result of the heightened demand levels, the group has sourced over $1 billion of fresh capital through asset sales and joint ventures, further reducing reported leverage while positioning the company to meet customers' growing needs.

Strategic growth initiatives

Both Equinix and Digital Realty have been focusing on developments and global expansion, catering to their multinational tenant bases and aiding overall leasing efforts. Customers increasingly seek multi-regional solutions amid strong global data centre demand and are the driving force behind new international development projects. Digital Realty generates around 50% of revenue from outside the Americas versus Equinix's 56%, with both adding to their portfolios in all regions.

Acquisitions in Africa during 2022 provide prime examples of each company's strategy. Equinix acquired MainOne, a leading West African data centre and connectivity solutions provider, with presence in Nigeria, Ghana and Côte d'Ivoire, establishing a presence in western Africa, followed by expansion into South Africa where Digital Realty is the largest provider after buying a majority interest in Teraco, Africa's leading carrier-neutral colocation provider - the first provider of highly resilient, vendor-neutral data environments in sub-Saharan Africa with world-class data centre infrastructure and network-dense ecosystems. Both intend to grow their exposure in the continent via development.

Valuation considerations

Barriers to supply growth in conjunction with AI-accelerated demand is expected to result in sustained pricing power in a sector that has been burdened by near-unlimited supply. In addition, data centre REITs have built dominant platforms through M&A and new developments, with market share gains more likely to increase rather than decrease in an environment of constrained capital availability.

The FTSE NAREIT Data Centres Index is currently trading towards the lower end of its fair value range despite robust activity within the sector. The long-term prospects for capital and income growth remain attractive due to ongoing development activity and as data centre REITs with extensive scale and a widespread presence hold a distinct advantage in leasing negotiations. This advantage is expected to intensify as the development and deployment of AI technologies matures on a global scale.

For more information regarding your investment, please contact your Portfolio Manager directly.

Regards
FNB