Suntec – DMG
Lehman Issue a Non-Issue
Lehman occupies minimal amount of office space. In the wake of Lehman Brothers’ (Lehman) debacle and subsequent Chapter 11 bankruptcy filing, its Singapore operations has also ceased after SGX suspended it from taking new securities and derivatives positions. As such, it is inevitable that we examine the implications for its present office landlord – Suntec REIT (SRT). We note that Lehman presently takes up approximately 40,000 sf of office space in Suntec City Office Tower Five. This represents a mere 3.1% of SRT’s total Suntec City Offices portfolio of 1.29m sf, and an even smaller 1.4% of its entire portfolio of 2.90m sf. Although Lehman employees have not vacated and talks over any possible settlement have yet to commence, we predict a minimal 0.9% dip in FY09 DPU in the event of a termination by end-Sep 08 and a replacement tenant cannot be found within the next six months. As such, exposure to the Lehman collapse is not a major issue. In any case, Lehman is legally obligated to fulfil its remaining lease tenure (renewed early last year) if termination occurs.
Staying on course for positive rental reversions. As Lehman’s lease agreement was only renewed in early-07 at the prevailing market rents then, SRT does stand to benefit from positive rental reversions if a new tenant were to step in. Most importantly, the organic drivers underlying Suntec City Office Towers remain intact, with a considerable 42.7% of the leases due in FY09 still paying at significantly below market rents, coupled with high occupancy levels. Other banking & financial services tenants within SRT’s portfolio, such as Deutsche Bank and UBS (Suntec City Office Towers), as well as Deutsche Bank, Credit Suisse, UBS, ABN Amro and Barclays (One Raffles Quay) have either remained relatively unscathed or managed to remain solvent.
Medium-term office story still stands. The recent signing of new leases at Marina Bay Financial Centre Phase 1, as well as new leases and renewals at Capital Tower and One George Street, provide positive reminders of Singapore’s growing position as a regional financial hub. At a time when the global investment climate is severely weakened, this implies that demand for office space remains and that the medium-term office story is still thriving.
Maintain BUY at S$1.87. Of late, office landlords, particularly office REITs, have been absorbing a sizable amount of flak on the back of global macroeconomic uncertainty, as well as expected falls in occupancy levels, dips in capital values and rental rates. The creeping up of unemployment rate (from 4Q07’s 1.7% to 2Q08’s 2.3%) has not contributed positively. Given the historically low P/B levels of office REITs at 0.5x currently, share prices appear to have factored in these negativities. Although we are not expecting the weakened sentiments to cool off anytime soon, we continue to believe that SRT will be able to grow organically. On a YTD comparison, it has also outperformed the other office REITs. Since the Street first got wind of Lehman’s highly possible collapse, SRT has slipped 15.0%. We believe any remaining overhang should evaporate with SRT’s limited exposure to Lehman. At present levels, the stock is trading at a FY08-09 yield of 7.2 – 8.7%, implying a 430 – 580 bps premium over the 10-year SGS bond yield of 2.9%. Maintain BUY at S$1.87.