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Morningstar | CoreSite Meets Our 1Q Expectations While Positioning Itself for Stronger 2020; Maintaining $105 FVE

CoreSite has repeatedly referred to 2019 as a transition year, when constrained capacity will limit its growth potential as it invests heavily in new development to better meet demand in 2020. The firm's first-quarter results reflected the slowing but were in line with our revenue, EBITDA, and funds from operations estimates, despite falling slightly below consensus. We expect improvement throughout the year, as new capacity comes on line, and better results in 2020. Ironically, one of the qualities we like best about CoreSite, its measured approach to expansion, is the culprit weighing on this year's potential, but we don't think it affects the firm's long-term opportunity. We see CoreSite's data centers as unique properties, primarily due to the number of networks that connect to them and their functions as Internet exchange points (the primary driver of our narrow moat rating), so we don't view this as a missed opportunity or see any shortage of demand once CoreSite has capacity available. We are maintaining our $105 fair value estimate and see shares as fairly valued.

Year-over-year revenue growth was just over 7%, tracking the roughly 8% growth we project this year, but flat sequentially for the second straight quarter. We expect sequential growth to return in the second quarter--when increased capacity is due to come on line in Los Angeles and Virginia--and we project the second half of the year to be significantly stronger, with new capacity available (and mostly already leased) in Santa Clara and Boston (the two markets with over 90% occupancy). In 2020, we forecast revenue growth to return to the midteens it has reached every year this decade.

The firm reported $1.25 in FFO per share and a 53.6% adjusted EBITDA margin, both nearly identical to last quarter. We project margins to expand slightly through the year as the firm monetizes new capacity that has already led to some expenses. We project a 54% adjusted EBITDA margin in 2019 and over 55% in 2020.

CoreSite has seen good preleasing activity on its new construction, which is expediting its planned development and will lead to higher capital expenditures in 2019 than the firm previously expected. After the quarter ended, the firm preleased 108,000 square feet in the Santa Clara data center it is building, equaling all the space the firm plans to complete in 2019 and accelerating further capacity expansion on that campus. CoreSite now expects 2019 capital spending of $425 million to $500 million, and we are increasing our estimate by about $30 million to reach that range. We expect 2019 to be the high point of the firm's capital spending for the foreseeable future. We project it to be about $100 million lower in 2020.

Apart from the new Santa Clara data center, the firm signed 121 leases for 32,000 total square feet during the quarter, which represents $6.6 million in annualized rental revenue, the firm's best quarterly result in over two years. Promising near-term preleasing activity will not affect our revenue estimates, as we already expect good leasing activity, and the firm will also see a bit higher churn than anticipated due to the bankruptcy of one of its tenants. Still, we think it validates CoreSite's current expansion.