Suntec – OCBC

Bond rate volatility continues


Dilution, yes, but reflected in our estimates. Suntec REIT (Suntec) issued the first of six installments of deferred units last week. These deferred units formed part of the payment for Suntec’s original portfolio at its IPO, allowing Suntec to offer a higher yield at listing. The 34.5m units are not entitled to distributable income from the current quarter but will then be aggregated with Suntec’s existing units. The other five installments will be issued at half-yearly intervals over FY09-10. All in, the 207m shares imply about 14% dilution to unitholders. We emphasize that both our fair value and DPU estimates have always taken this dilution into account.

Bond rate volatility will continue. Last week, the 10-year Singapore government bond (SGB) yield hit 3.94%, a 152 bps spike since our last report on Suntec dated 2 May. Now at 3.6%, such high rates have not been seen since 2006. We expect interest rate volatility to persist as inflation concerns shape central bank policy and the prospects for a US rate hike increase. We also expect spreads to be impacted as credit market woes persist.

Suntec trading below its historical average spread. This month, Suntec has been trading as low as 200 basis points over the 10-year SGB yield. Historically, its average spread over the benchmark has been 269 bps. This has been a tumultuous few months for Suntec – in March this year, it was trading at a 441 bps spread, a record high. It last traded below its historic average in 2007, where at one point Suntec was trading at only 123 bps over the 10-year SGB yield (see Chart 1). Those were far more benevolent circumstances however.

Still worth a look. Suntec had hit S$1.68 since our last report but rising bond rates and a negative trending consensus has driven its price back to S$1.51, or 13% below our S$1.71 fair value. It is currently trading at 249 bps over the 10-year SGB yield. We believe Suntec still merits a look and feel its near-term growth will be driven by rent reversions – about 44% of the office portfolio ex-ORQ is up for renewal in FY09 and significant upside remains for its properties earning less than S$5-S$6 psf pm. We maintain our BUY rating but will continue to monitor the volatility in bond rates and how it plays out.