3 Things Digital Realty Trust Inc.'s Management Wants You to Know

By Markets Fool.com

Digital Realty released fourth-quarter earnings last Tuesday and recorded a net income loss of $0.39 per share.

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However, because net income includes depreciation of real estate and one-time charges, it can mask what is actually happening with Realty Income's operations. For that reason, real estate investment trusts, REITs, are most often judged using adjusted funds from operation, or AFFO, which pulls out these non-cash and one-time charges to give investors more insight into how much cash is being generated from operations.

Digital Realty reported core funds from operation -- which is Digital Realty's version of AFFO -- of $1.26 per share. Which not only completely changed the picture for the quarter, but actually beat consensus estimates by $0.02 per share.

But, if you want to really understand Digital Realty's quarter you have to go beyond the headline numbers, and listening to the company conference call is one of the best ways to do that. Here are three things that stood out during Digital Realty's fourth-quarter 2014 conference call.

1. Capital recycling
Digital Realty has been discussing a "capital recycling" plan, in which the company will sell off non-essential properties in hopes of putting the capital to better use.

In the third quarter of 2014, the company identified nine properties to sell. According to Chief Investment Officer Scott Peterson, "During the fourth quarter, we determined to bring an additional eight properties to market." That brings the total to 17 out of 131 properties.

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The plan kicked off in October with the "sale of its $17 million investment in a developer of data centers in the Southwestern U.S. and Mexico." Digital Realty took a realized a gain of $15 million on the deal. The company made its second transaction earlier this year, and generated a $29 million realized gain through the sale of a 169,000-square-foot office building.

Digital Realty is expecting to dispose of an additional $175 million-$400 million worth of properties in 2015. Doing so should help focus the company's assets, as well as supply it with ample cash to make future investments without taking on additional debt.

2. Lease activity
Although the capital recycling plan is worth watching, nothing is more important to Digital Realty's success than keeping its properties occupied, because without tenants, there's no cash flow.

In the fourth quarter, the company made progress signing new leases and renewing existing ones. Occupancy ticked up to 93.2% at the end of 2014, from 92.6% during the same time in 2013.

Most intriguing, Matt Miszewski, senior vice president of sales and marketing, suggested that "existing customers accounted for nearly 90% of our lease signings again in the fourth quarter." That existing tenants continue to renew their leases as well as rent additional space is a testament to the quality of service the company provides and the sticky relationship it has with tenants.

Lastly, while releasing is nice, releasing at higher rents is even nicer -- and that's exactly what happened. Rental rates on Digital Realty's renewals increased by 4% over previous rates for its total portfolio of data centers. That's a good sign that demand for Digital Realty's space is strong.

3. Zayo Group
Management reiterated the November announcement that it has strengthened its relationship with Zayo Group, an international provider of bandwidth infrastructure. Digital Realty's relationship with Zayo will give its customers access to a private line to several top cloud providers, increasing both security and speed. According to Digital Realty CEO Bill Stein, "We saw the first orders for this new product within weeks after rolling it out."

Moreover, according to Stephen Smith, the CEO of Equinix, one of Digital Realty's top competitors, "[S]ecure private access between cloud consumers and cloud service providers is now the fastest-growing category ofinterconnection at Equinix." Enhancing this service makes Digital Realty more competitive, creates opportunities, and builds a better user experience for customers.

Looking forward
Digital Realty has an obvious bias in pointing out why its stock is undervalued. To be fair, with a 22% annual total return during the past decade, it has been one of the top-performing REITs. Yet it's trading at about 14 times 2015 earnings estimates, significantly lower than the industry average of 17.5.

The lower valuation is likely due to the capital recycling plan, which will slow growth in the near future. In fact,management set 2015 earnings guidance between $5 and $5.10 per share. At the low end, that would be less than a 1% improvement over earnings of $4.96 during 2014 -- and that's not so great.

But my thesis is unchanged. Digital Realty is still a strong player in a growing industry, it has made strides to improve its standing in 2014, and I expect it to continue to be a top-performing REIT far into the future.

The article 3 Things Digital Realty Trust Inc.'s Management Wants You to Know originally appeared on Fool.com.

Dave Koppenheffer has no position in any stocks mentioned. The Motley Fool recommends Equinix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.