Suntec – OCBC

A solid second quarter

Solid second quarter. Suntec REIT (Suntec) reported a 34.2% YoY increase in 2Q distributable income to S$37.6m. The REIT will pay out 2.5185 cents DPU, up 28.2% YoY and more than 10% higher QoQ. The strong DPU exceeded both Suntec’s own forecasts and our estimates. We have now increased our expectations for full-year DPU by 5% to 9.6 S cents. Our 2H08 and 1H09 estimates together imply an attractive 6.5% distribution yield for the next 12 months.

Growth drivers. The biggest highlight of the story was the significant control on expenses in 2Q. NPI margins increased from 68.8% in 1Q08 to a staggering 76% in 2Q08. This was primarily due to a 47% decline in property taxes QoQ. Revenue, meanwhile, was boosted by the Suntec City office towers. About 152,000 sf of office space came up for renewal in 2Q, and this accounted for the bulk of the total estimated leases up for renewal in FY08. Renewal rates for these spaces rose meteorically from below S$5 psf pm to S$11-13.50 psf pm. The REIT’s office strata shopping spree – it has acquired about 28,000 sf over December and January – added another boost. About 5% of Suntec’s retail portfolio also enjoyed positive rental reversions. One Raffles Quay (ORQ) made its first full-quarter contribution as well, earning S$2m in net profit.

What next? Suntec is nearing peak performance on its current portfolio. Occupancy, its first avenue for organic growth, is maxed out at 99.8% (office) and 99.4% (retail). Growth will be driven by rent reversions – about 44% of the office portfolio ex-ORQ is up for renewal in FY09. We expect office rentals to peak by 1H09 and hold, but there is still significant upside for its properties earning less than S$5 psf pm. ORQ rent reversions will start gaining traction only in FY11. In our view, the next wave of mediumterm growth will be external, including more office strata buybacks in Suntec City and the planned addition to Park Mall.

Compelling yield. While Suntec is consistently outperforming as a business, it is operating in a far more muted S-REIT environment. The property market on the whole remains spooked by questions about the health and prospects of both the local and global economy. This caution and skepticism have filtered down to S-REIT prices, presenting a great yield opportunity. We continue to like Suntec for repeatedly bringing home the bacon with a quality 6.5% yield. Maintain BUY with a S$1.71 fair value.