Suntec – MS

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Higher yield required as less superior to CCT: We are maintaining our Equal-weight rating on Suntec REIT on a lower price target of S$0.68 (from S$0.91). In addition to reducing our rental assumptions for its assets, our new price target attempts to capture the risk of our bear case scenario panning out, as the macro environment continues to deteriorate, by assigning a 20% probability to our bear case. A base case DCF-driven NAV suggest a value of S$0.77 for Suntec, on a fully diluted basis. In our view, the risk-reward offered by CapitaCommercial Trust, our new sector top pick with 14.5%-13.6% DPU yield, is more attractive than Suntec’s 13.3%-13.5% yield. We prefer CCT’s higher-quality asset portfolio, leasing track record and balance sheet, backed by its strong parent, CapitaLand.

Too early to ascertain refinancing risk, as its S$700m debt refinancing is only due in December 2009. According to management, banks remain keen to work with Suntec on its refinancing but are reluctant to commit to funding rates ahead of time. On a positive note, our economics team is currently expecting SIBOR to be 0.6% by 2009 year-end and 2.1% by 2010 year-end. If rates remain below 1% in 2009, this would be positive for S-REITs as further increases in required spreads from the current 200-250bp would be cushioned by the lower SIBOR or swap rates. At a current leverage of 33%, Suntec has room to absorb a 200bp to 320bp cap rate expansion before it hits the 50% and 60% marks. This translates to a 35% to 46% devaluation in its asset portfolio respectively. We believe this buffer is sufficient for the next 12 months at least.

Sector dependent on macro recovery: The market is likely to remain skeptical on the viability of the S-REIT business model given its heavy reliance on credit and will be keeping a watch on the ability and cost of the S-REIT debt refinancing in 2009. For now, we believe S-REITs are likely to trade in line with the STI Index.